University of Florida Levin College of Law UF Law Scholarship Repository

UF Law Faculty Publications Faculty Scholarship

2014

The Puzzling Lack of

Peter Molk University of Florida Levin College of Law, [email protected]

Follow this and additional works at: https://scholarship.law.ufl.edu/facultypub

Part of the Business Organizations Law Commons

Recommended Citation Peter Molk, The Puzzling Lack of Cooperatives, 88 Tul. L. Rev. 899 (2014)

This Article is brought to you for free and open access by the Faculty Scholarship at UF Law Scholarship Repository. It has been accepted for inclusion in UF Law Faculty Publications by an authorized administrator of UF Law Scholarship Repository. For more information, please contact [email protected]. The Puzzling Lack of Cooperatives

Peter Molk*

Some ofthe most ecognizable companies, icludngLand O'Lakes, REZ the Associated Pass,Ace Hardware,and State Farm nsurance,arm organzedascoopemtives-firms owned by their suppliers, workers, or customers. Yet aside from isolated arras of the economy cooperatives constitute only a small portion of Amencan enterpnse which is otherwise dominated by investor-owned inms Conventional wisdom assumes that irms either start as cooperatives or convert to cooperatives when cooperatives offer the highest ongoing benefits to owners, and it explains the lack ofcooperatives by suggesting that cooperatives usually do not maxinie ongoing benefits. This Article looks at entpreneus' and brokers' actions when siarting or converting finms. It fmds that the conventional assumption is oaften violated Starting a is similarto supplying a publcgood andjustas unsubsidizedpublic goods are underprvided so too are unsubsidzed cooperative starts Additionaly a lack of viable bokerng institutions prevents most existing firms from converting to cooperatives even when cooperativespronise the hghestongoing benefits These findgs explain cooperatives'lowmarketshare andseveral empircalobservations that are iconsistent with the conventional wisdom. The results suggest social welfare could be improved if cooperatives were subsidzed through favorable tax tratmen4 grants, or regulatoryintervention like ABA rules requirnglaw frms to be owned by lawyers. They also question the shareholderprimacy model of corporate governance The Article closes by briefly considerng the Affordable CareActk current$2 billion subsiation of health insurance cooperatives

I. INTRODUCTION...... 900 II. PRINCIPLES OF OWNERSHIP AND THE EVOLUTIONARY THEORY ...... 905 III. COOPERATIVES ...... 910 A. CooperativeFundamentals ...... 910 B. CooperativeBenefits...... 912 1. Producer Cooperatives...... 913 2. Worker Cooperatives ...... 917 3. Consumer Cooperatives ...... 919 4. Drawing It Together: What Matters for Cooperative Ownership ...... 922

d * 0 2014 Peter Molk. Assistant Professor, Willamette University College of Law. Thanks to Dave Anderson, Amitai Aviram, Ian Ayres, John Colombo, Chris Griffin, Henry Hansmann, Paul Heald, Christine Hurt, David Hyman, Jay Kesan, John Morley, Minor Myers, Elizabeth Pollman, George Priest, Arden Rowell, Dan Schwarcz, Paul Stancil, Suja Thomas, Tom Ulen, Andrew Verstein, Melissa Wasserman, Lesley Wexler, Cindy Williams, Verity Winship, Joe Yockey, workshop participants at Michigan State University and Washington University, and participants at the Big Ten Junior Law Faculty, the Midwest Law and Economics, and the National Business Law Scholars Conferences for insightful conversations and comments. 899 900 TULANE LA WREVIEW [Vol. 88:899

C CooperativeCosts...... 926 D Problems with Extending the Evoludonary Theory ...... 928 IV BARRIERS TO COOPERATIVE FORMATION ...... 929 A. Entrepreneurs: Public Goods Problem...... 930 B. BrokerDifficuldes...... 935 C What Does This Theory Explain ?...... 939 1. Lack of Cooperative Presence in High-Gains Areas ...... 939 2. Strong Performance of Existing Cooperatives...... 941 3. Persistence of Cooperatives Once Formative Influence Is Removed ...... 942 D AppropnatelyApplying the Evoludonary Theory...... 943 E Implicationsfor ShareholderPimacy...... 944 E Summary ...... 945 V SUBSIDIZING COOPERATIVES ...... 945 A. GeneralTax or GrnntIncentives...... 946 1. Encouraging Initial Formation Through the Tax Code ...... 947 2. Alternatives to the Tax Code ...... 949 3. Encouraging Ongoing Operation? ...... 950 B. Reducing Reguladon...... 952 C Other Tools...... 953 D. How Much To lncentivize?...... 955 E, An Application: HealthInsurance Cooperadves...... 956 VI. CONCLUSION ...... 957

I. INTRODUCTION Land O'Lakes. Sun-Maid Raisins. Ocean Spray. REI. Vanguard. State Farm Insurance. Northwestern Mutual. Ace Hardware. The Associated Press. The makers of Gore-Tex. What do these organizations have in common? All are pillars of American enterprise operating in diverse sectors of the economy. All are cooperatives.'

1. Our Story, LAND O'LAKEs, http://www.landolakes.com/OurStory/ (last visited Mar. 22, 2014); About Sun-Maid SUN-MAID, http://www.sunmaid.com/about-sun-maid.html (last visited Mar. 22, 2014); Our History,OCEAN SPRAY, http://www.oceanspray.com/VWho- We-Are/Heritage/Our-History.aspx (last visited Mar. 22, 2014); REI Overview, REI, http:// www.rei.com/about-rei/business.html (last visited Mar. 22, 2014); Bill McNabb on the Markets, the US Debt Cnsis, and Fee Was VANGUARD (Dec. 6, 2012), https://www. vanguardinvestments.de/content/de/en/articles/insights/markets-and-economy/bill-mnabb-on- the-markets.shtml; Company Overview, STATE FARM, https://www.statefarm.com/about-us/ 2014] THE PUZZLING LACK OF COOPERATIVES 901

The defining feature of a cooperative firm is that it is owned by its suppliers of inputs, its workers, or its customers. These owners receive both the cooperative's profits and control the firm. A quintessential cooperative grocery store, for example, is owned by its customers. In contrast, most large-scale enterprises are owned by outside investors having no relationship with the firm other than as investors. These unique features of cooperatives affect all aspects of the firm, from how it is run to how and what it produces. Cooperatives have received renewed attention. The United Nations proclaimed 2012 the International Year of Cooperatives,2 and the United States Senate passed an honorary resolution to the same effect.' The United States Congress devoted $2 billion to subsidize health insurance cooperatives as part of the Affordable Care Act.4 The management consulting firm McKinsey and Company published a comprehensive report dedicated to various aspects of cooperative development.! The financial crisis and ensuing economic stagnation have reinvigorated calls for alternatives to investor ownership.' And after a period in which cooperatives were largely overlooked by academics, research is once again beginning to turn toward this organizational form. company-overview/ (last visited Mar. 22, 2014); Company Overiew, Nw. MUTUAL, http:// www.northwesternmutual.com/about-northwestern-mutual/our-company/company-overview. aspx#Mutuality (last visited Mar. 22, 2014); Frequently Asked Questions, ACE, http:// www.acehardware.com/corp/index.jsp?page-faq (last visited Mar. 22, 2014); About Us, ASSOCIATED PRESS, http://www.ap.org/company/about-us (last visited Mar. 22, 2014); see GAR ALPEROVITZ, AMERICA BEYOND CAPITALISM 83 (2005) (explaining that Gore-Tex is a cooperative firm). 2. International Year of Cooperatives 2012, UNITED NATIONS, http://social.un.org/ coopsyear/ (last visited Mar. 22, 2014). 3. S. Res. 87, 112th Cong. (2011) (enacted). 4. Establishment of Consumer Operated and Oriented Plan (CO-OP) Program, 76 Fed. Reg. 77,392 (Dec. 13, 2011) (to be codified at 45 C.F.R. pt. 156); The CO-OP Health Insurance Pgramn, HEALTH AFFAIRS (Feb. 28, 2013), http://healthaffairs.org/healthpolicy briefs/brief pdfs/healthpolicybrief 87.pdf 5. McKinsey on Cooperatives,MCKINSEY & CO. (2012), http://www.mckinsey.com/ clientservice/strategy/latestjthinking/-/media/C22BEB228D8448968296276626A181 BB.a shx. 6. Linda D. Phillips, Worker Cooperatives: Their Tme Has Arnive4 40 COLO. LAW. 33, 33 (2011); Nancy Folbre, The Case for Worker Co-Ops, N.Y TIMES EcoNoMIX (Nov. 23, 2009, 7:45 AM), http://economix.blogs.nytimes.com/2009/11/23/the-case-for-worker-co-ops/. 7. For examples of recent work, see Partha Dasgupta, New FrontiesofCooperation in the Economy, 1 J. ENTREPRENEURIAL & ORGANIZATIONAL DIVERSITY 7 (2012); Henry Hansmann & Mariana Pargendler, The Evolution ofShareholder Vothg Rights: Separation of Owneshi and Consumption, 123 YALE L.J. 100 (2014); Gowri J. Krishna, Worker Cooperatve Creationas ProgressiveLawyenng? Moving Beyond the One-Peason, One-Vote Floor,34 BERKELEY J. EMP. & LAB. L. 65 (2013); Ariana R. Levinson, Founding Worker Cooperatives: Social Movement Theory and the Law, 14 NEv. L.J. (forthcoming 2014); Marc 902 TULANE LA WREVIEW [Vol. 88:899

Collectively, cooperatives account for $1.6 trillion in revenue, $500 billion of which is produced within the United States.! While this presence is not insignificant, it is dwarfed by the more common investor-owned firm. Value added from cooperative operations is on the order of only 1%of the U.S. gross domestic product (GDP)." This pattern of ownership is puzzling given both the theoretical and demonstrated advantages the cooperative form has to offer. " Conventional explanations focus on theoretical costs of particular types of cooperatives to explain their observed absence from the economy at large, arguing that in most cases the costs of cooperative ownership outweigh its benefits.12 These explanations rely heavily upon an evolutionary theory of ownership: over the long term, cooperatives succeed in certain sectors because characteristics of those sectors enable cooperatives to outcompete alternative ownership types, and cooperatives do not penetrate other sectors because characteristics of those sectors lead cooperatives to be inefficient." This theory is essentially an application of Darwin's "survival of the fittest" to organizational forms. The theory gives scant attention to how firms are started, because it assumes firms either start as, or convert to, cooperatives if cooperatives maximize owners' ongoing net benefits. If this assumption is violated, then cooperatives will be underrepresented in the economy at large, in spite of ongoing efficiencies they offer,

Schneiberg, Toward an Organizationally Diverse American Capitalism? Cooperative, Mutual, and Local, State-Owned Enterpise, 34 SEATTLE U. L. REv 1409 (2011); Justin Schwartz, Were Did MIl Go Wrong? Why the Capital-ManagedFirm Rather than the Labor-Managed EnterpnseIs the PredominantOrganizational Form in Market Economies, 73 OHIO ST. L.J. 219 (2012). 8. Global300 Report,2010, INT'L . ALLIANCE 2, http://2012.coop/sites/default/ files/attachments/Global300%20Report%20201 1.pdf (last visited Mar. 22, 2014). 9. Steven Deller et al., Research on the Economic Impact of Cooperatives,UNIv. OF Wis. CTR. FOR Coops. 2 (June 19, 2009), http://reic.uwcc.wisc.edu/sites/all/REICFINAL. pdf. 10. Compare id. (finding $133.5 billion of value-added from cooperatives), with GDP (Current US $),WORLD BANK, http://data.worldbank.org/indicator/NY.GDPMKTP.CD (last visited Mar. 22, 2014) (listing U.S. GDP as $15 trillion). Cooperatives' share of total wages is also small, estimated at $25 billion out of a countrywide total of $6 trillion, or 0.4% of all wages. Compare Deller et al., supra note 9, at 2 (finding $25 billion in cooperative wages), with Establishments,Employment, and Wages, 2001-2010AnnualAvriges BUREAU OF LABOR STATISTIcs, http://www.bls.gov/cew/ewl0tablel.pdf (last visited Mar. 22, 2014) (showing $6 trillion in total wages in the United States). 11. These advantages are discussed infra Part Ill. 12. HENRY HANSMANN, THE OWNERSHIP OF ENTERPRISE 24-49 (1996). 13. Id.at 22-23. By efficient, I mean the maximization of not just financial benefits, but all benefits, emotional or otherwise, gained by persons dealing with the firm, as long as they are willing to pay for them. See id. at 23. 2014] THEPUZZLINGLACK OF COOPERATIVES 903 because of particular constraints faced by cooperative entrepreneurs. In that case, survivorship provides only an incomplete picture of cooperatives' potential success. This Article finds that this assumption is often violated. Because of unique attributes of the cooperative form, cooperatives are more difficult to organize than investor-owned counterparts. 14 The entrepreneur who organizes as a cooperative instead of as an investor- owned firm supplies what is in essence a public good, and just as unsubsidized public goods are undersupplied, so too are cooperative starts. A cooperative entrepreneur must share much of the firm's profits with comembers instead of capturing them for herself. Therefore, unless entrepreneurs derive satisfaction from the well-being of others or the cooperative offers exceptional advantages over investor ownership, cooperatives will not start even if they maximize owners' returns." Compounding the problem, in most situations coordination difficulties and a lack of established broker institutions keep existing investor-owned firms from converting to cooperatives, even when the cooperative form has higher ongoing net benefits. Thus, while in many instances investor ownership truly is the superior ownership form, in others the cooperative would be the better choice, and yet the formative step is never taken. Investor ownership proliferates even in circumstances where it is comparatively inefficient. Examples of existing cooperative success identify only those situations where socially minded entrepreneurs left their mark or where the net benefits of cooperative ownership so far exceed investor ownership that cooperatives surmount their start-up barriers. This finding yields several policy implications. First, since in some unexploited industries cooperatives could maximize ongoing benefits from ownership once they started, social welfare could be

14. Throughout this Article, I contrast cooperatives with investor-owned firms. The key difference between the two is how cooperatives use their ownership structure to overcome market contracting failures that arise with investor-owned firms. See infra Part II. As will become clear, these same failures also arise with a variety of closely held firms such as sole proprietorships, some partnerships, and even some firms that might resemble cooperatives in certain respects. See bird notes 108-114 and accompanying text. Investor-owned firms are the most visible embodiment of this situation, so it is the term I use throughout the Article to refer to this more general situation. The line between the two can become blurred. See birf notes 108-114 and accompanying text. 15. In economic terms, although the entrepreneur may maximize social welfare by organizing as a cooperative, she will generally not start the cooperative because much of this welfare is a positive extemality that benefits others from her perspective; she maximizes her personal welfare by choosing the investor-owned firm. 16. SeeinfaPartlV 904 TULANE LAWREVIEW [Vol. 88:899

improved by subsidizing cooperatives. Tax subsidies, grants, or regulatory interventions, like American Bar Association (ABA) rules requiring cooperative ownership of law firms by lawyers, are ways to achieve this goal. Second, arguments for a shareholder primacy theory of corporate governance, in which management is answerable exclusively to the economic interests of shareholders, may be weaker than previously thought. These arguments attribute cooperatives' rarity to theoretical costs from management's being answerable to diverse cooperative owners, but if cooperatives' low market share is instead driven by formation difficulty, these management agency costs may be overstated, as are the potential gains from having management responsible exclusively to homogenous investor-owners. Obtaining the appropriate mix of firm ownership is a crucial issue of public importance. Most broadly, when investor ownership is inefficiently chosen as the organizational form merely because it is easy to start, society's capital is tied up in organizations that produce at higher cost than necessary, translating into higher prices and inferior products. But the importance of ownership structure transcends minimizing the costs of products and services. Ownership structure affects every interaction with a firm. It can determine whether and how public goods are provided, whether costly government regulation is necessary, whether workers are happy, or whether customers are exploited. For example, if more banks were organized as consumer cooperatives instead of as investor-owned firms, perhaps the financial crisis would have been muted, given credit unions' lesser engagement in subprime lending-a result predicted by their organizational form." And finally, firm ownership can become a topic of heated political discussion-these issues were at the heart of capitalist-versus-communist debates of the 1950s and 1960s. This Article proceeds as follows. Part II introduces the concept of firm ownership and identifies why it matters. Here I use an

17. See "Credit Crunch: Is the CFPB Restricting Access to Credit?" Hearng Before the Subcomm on TARP,Fin. Servs. & Bailouts ofPub & Pnvate Programs ofthe H Comm. on Ovesight & Govt Reform, 112th Cong. 3 (2012) (testimony of Douglas A. Fecher, President and CEO of Wright-Patt Credit Union on behalf of the Credit Union National Association), avaulable at http://oversight.house.gov/wp-content/uploads/2012/07/ Fecher-Testimonypdf ("[C]redit unions did not cause the financial crisis; they did not seek or receive any taxpayer bailout; and they did not engage in the type of activity that prompted the creation of the [Consumer Finance Protection] Bureau."); Andrew Martin & Ron Lieber, Alternative to Banks, NowPlaying Offense, N.Y. TIMEs, June 12, 2010, at BI ("[M]ost credit unions did not engage in the type of risky lending that led to the [financial] crisis."). See generally Ryan Bubb & Alex Kaufman, Consumer Biases and Mutual Ownership, 105 J. PuB. EcoN. 39 (2013) (showing how credit unions are less likely to exploit consumer biases). 2014] THE PUZZLING LACK OF COOPERATIVES 905 example of possible owners of an insurance company to show the practical effects of ownership, while at the same time introducing the evolutionary theory that is important in traditional explanations of cooperative activity. Part Ell turns to cooperatives, firms whose owners are also either suppliers, workers, or customers of the firm. This Part provides an overview of where cooperatives have gained traction and develops how cooperatives are different from investor-owned firms. The intuition developed here will be used to identify inconsistencies with conventional accounts of firm ownership. Part IV tackles the core question: if cooperatives are efficient, why are they not more common? This Part examines entrepreneur and broker behavior and finds that in most circumstances, cooperatives will not appear even when they maximize owners' ongoing benefits. This finding explains several empirical observations that the conventional wisdom cannot. Part V addresses the policy issue: what should be done in those circumstances where cooperatives are efficient but face barriers to formation? This Part considers how cooperatives could be subsidized through tax policy, direct government financial subsidy, or regulatory policy. It closes by showing how this approach could be applied in practice, using the new Affordable Care Act subsidy of health insurance cooperatives as an example.

II. PRINCIPLES OF OWNERSHIP AND THE EVOLUTIONARY THEORY Most firms are owned by investors." Many people take this fact as a given, yet it need not be the case. Does it matter who owns the firm? Does it make sense that most firms are owned by investors? This Part answers these questions: the first with an emphatic "yes" and the second with a "maybe." Three broad groups could be owners, or those with formal control rights and the right to receive the firm's profits." First, there

18. HANSMANN, supm note 12, at 12. 19. Id. at 21. In theory, the right to control and the right to receive residual profits could be separated and assigned to different classes, but in practice such separation rarely occurs because of the incentive incompatibility resulting from having those in control not answerable to those with residual claims. Id. at 12. Venture capital and private equity firms are conspicuous examples where the right to control is separated from the right to residual assets. Investors in these firms have no effective control rights. See generally Ronald J. Gilson, Engineernga Venture CapitalMarket: Lessons from the Ameican Expeience, 55 STAN. L. REv. 1067, 1071-72 (2003) (describing the organization of venture capital firms). 906 TULANE LA WREVIEW [Vol. 88:899 could be no owners-the firm could be a nonprofit, in which no class has the right to receive residual profits.20 Second, owners could be suppliers of equity-in other words, the firm could be investor- owned.2' These firms' defining feature is that the formal rights to control and residual profits are tied only to how much capital a closed group of investors provides.22 Finally, owners could be a class having a relationship with the firm beyond mere provision of equity. The firm could be owned by its suppliers of inputs, by its workers, or by its customers. In this case, the firm is a cooperative.23 A fundamental issue to be addressed when starting a firm is the organizational form to adopt. Most literature on entity choice analyzes which form within a particular ownership structure is efficient. For example, within investor ownership, are limited liability companies, partnerships, or publicly held corporations best?24 This Article instead focuses on which ownemsbp structure as between investor ownership and cooperative is better. I sketch here an example of how ownership structure matters, leaving a systematic development to Part 111. Ownership choice can be considered as one of the inputs factoring into the firm's production process.25 If ownership of a life insurance company is assigned to external investors,2 as occurs with the standard business corporation,2

Generally, the right to residual assets and the formal right of control are bundled together, and this Article considers primarily this case. 20. Henry B. Hansmann, The Role of Nonprofit Enterprise,89 YALE L.J. 835, 838 (1980). 21. Investor-owned firms may not always be "purely" investor-owned, as when the management of a publicly traded corporation may get bonuses if the company does better, in effect giving some workers a claim to residual assets. Or one member of a two-person partnership may initially contribute "sweat equity" instead of financial capital. In all these circumstances, however, there is the potential for contracting market failures that I discuss h2fia Part III. See also sources cited supm note 14. 22. HANSMANN, supranote 12, at 13. 23. Because this Article focuses on private ownership of firms, it will not deal with governmental ownership of firms, such as a municipally owned water supply or state-owned educational facilities. 24. See, e g., LARRY E. RIBSTEIN, THE RISE OF THE UNCORPORATION (2010) (discussing the ownership and governance of partnerships and limited liability companies). 25. See HANsMANN, supra note 12, at 12-16. See generallyRIBSTEIN, supra note 24 (analyzing how the choice between standard corporate forms or limited liability corporations and partnerships influences the interactions among owners and managers). 26. Throughout this Article, investor ownership will refer to firms owned by contributors of equity who have no other relationship with the firm unless specified otherwise, which comports with a common understanding of the term. As will become clear later, cooperatives also have investor-owners in a sense, but these investors have another relationship as supplier, worker, or customer. 27. HANSMANN, supa note 12, at 12-13. 2014] THE PUZZLING LACK OF COOPERATIVES 907 financing may be cheap and plentiful, providing both for savings that can be translated into lower prices as well as for easy business expansion.28 The insurer's management, however, has the incentive to exploit policyholders' lock-in to long-term contracts2 and sell inferior insurance to produce profits for investors." If, on the other hand, ownership is assigned to policyholders, the direct incentive to expropriate from policyholders is removed. The policyholder-owned insurer may therefore provide a better product for which policyholders will gladly pay. However, because the policyholder-owned firm lacks access to broad equity markets, costs of capital are greater." Finally, if ownership is assigned to the insurer's workers, wages (and costs) may rise, yet be offset by increased productivity stemming from ownership's motivating force on workers." However, costs of capital are, again, greater." Choice of ownership involves selecting one of these comparative advantages to the exclusion of the others.' The example shows how assigning ownership to a class of participants enables the firm to convert a relationship for which it would ordinarily have to contract on the market into a feature of ownership, saving those market-contracting "transaction" costs. The investor-owned firm, for example, foregoes some of its market contracting for financing-and by extension does not incur the transacting costs of debt-by making investors the owners in exchange for their capital contributions." But ownership creates its own costs," which I return to in Part UI.C.

28. See infia notes 119-121 and accompanying text. 29. Life insurance policies are routinely written for ten, twenty, or thirty years. Since these policies are written so that premiums during early years subsidize premiums in later years, a policyholder who switches companies before the end of a contract term forfeits the accumulated subsidy. See Henry Hansmann, The Orgamzation of Insurance Companies: Mutual versus Stock, 1 J.L. EcoN. & ORG. 125, 132-33 (1985). 30. Indeed, this situation was a motivating factor behind forming cooperatively owned life insurance companies (known as "mutuals" in the insurance area) and in the conversion of several investor-owned life insurers to mutuals in the 1950s. Linda Pickthorne Fletcher,Motivations Underlyig the Mutualizadon ofStock Life InsuranceCompanies, 33 J. RISK & INS. 19, 21-22 (1966) (describing the conversion of investor-owned life insurers to mutually-owned companies as an effort to achieve, among other benefits, "curtailment of the insurance company stockholders' profit-making opportunities ... and other abuses"); Hansmann, supra note 29, at 132-33 (describing this problem as a reason for life insurance mutuals' early success). 31. See infa notes 119-121 and accompanying text. 32. SeeinimPartIII. 33. HANsMANN, supranote 12, at 21-22, 107. 34. Id.at 21-22. 35. Id. at 53-58. 908 TULANE LA WREVIEW [Vol. 88:899

Market incentives push firms to maximize the net benefits resulting from choice of ownership, leading them to choose an "efficient" form of ownership-the form that maximizes the difference between benefits and costs of ownership." Firms that adopt some other form will be outcompeted by competitors that have adopted the benefit-maximizing form-the Darwinian "evolutionary" approach to ownership." Remember that these benefits and costs are not confined to financial benefits, but include all benefits and costs, emotional or otherwise, to persons dealing with the firm.39 Assigning a rough number to our insurance example helps make the point. Suppose the insurer offers 1000 identical insurance policies and, taking investor ownership as the baseline, its cost of doing so is $1,000,000. The insurer therefore charges $1000 per policy. If customers own the insurer as a cooperative insurance company, its cost of doing business increases by $100,000 to reflect higher costs of capital.40 The insurer therefore charges $1100 for this policy. Finally, if workers own the insurer, its cost of doing business (relative to investor ownership) increases by $100,000 to reflect a higher cost of capital and by a further $50,000 to pay for improved working conditions but decreases by $60,000 because the workers work more

36. Id at 33-49. Thesecosts are particularly great when there is more than one class of owners-so great that their costs regularly exceed the savings of avoided market contracting costs, which is why firms usually have at most one class of owners. Id at 44 (dividing ownership among several classes "threatens to increase the costs of collective decision making enormously"); FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE EcoNoMIC STRUCTURE OF CORPORATE LAW 37-38 (1991) ("[A] manager told to serve two masters ... has been freed of both and is answerable to neither."). 37. Hansmann, supm note 20, at 838; see also Eugene F Fama & Michael C. Jensen, Sepaation of Ownership and Control, 26 J.L. & EcoN. 301, 301 (1983) (analyzing firms' incentive to maximize benefits of ownership); Larry E. Ribstein & Bruce H. Kobayashi, Choice of Form and Network Externalities 43 WM. & MARY L. REv 79, 81-82, 128 (2001) (finding closely held firms choose ownership forms to maximize benefits of ownership). 38. Armen A. Alchian, Uncertainty Evolution and Economic Theory 58 J. POL. EcoN. 211, 216 (1950); Eugene F Fama & Michael C. Jensen, Agency Problems and Residual Claims, 26 J.L. & ECON. 327, 333 (1983). The evolutionary theory provides a powerful explanation for legal institutions beyond ownership form. See, eg., Robert C. Ellickson, Propertyin Lang 102 YALE L.J. 1315, 1357-62 (1993) (applying this theory to the challenge of identify ing efficient land-use institutions). 39. See supra note 13 and accompanying text. 40. Both "cooperative" and "mutual" are terms that generally refer to an organization owned by its customers. See RICHARD B. HEFLEBOWER, COOPERATIVES AND MUTUALS INTHE MARKET SYSTEM 3, 213 n.1 (1980). For historical reasons, cooperative insurance companies outside health insurance are referred to as mutuals. Id. at 162-76; PAUL STARR, THE SOCIAL TRANSFORMATION OF AMERICAN MEDICINE 295-306 (1982) (discussing cooperative health insurers). 2014] THE PUZZLING LACK OF COOPERATIVES 909 efficiently. As a result, the insurer's total costs are $1,090,000, and the insurer therefore charges $1090 per policy. In this example, if the policy is identical across insurers, then policyholders will patronize the investor-owned company because it offers policies at the cheapest price. Over the long-term, the investor- owned company will outcompete its policyholder- and worker-owned counterparts until only the investor-owned insurer remains. Applying the evolutionary theory suggests that over long time horizons, the ownership form that outcompetes alternatives is the form that has maximized the net benefits of ownership associated with producing that firm's particular product.4 1 For some products, more than one ownership form may persevere if there is demand for different attributes associated with those products. For example, some policyholders will prefer high-quality, policyholder-friendly insurance, while other policyholders are willing to sacrifice quality for a lower price. 42 In that case, one ownership form (policyholder-owned cooperatives) will provide the high-quality product at the cheapest price, while another ownership form (investor-owned) will provide the low-quality product at the cheapest price, and both ownership forms might coexist." Within each type of product, however, one would expect a dominant form of ownership to emerge over the long term. Policyholder-owned insurers would exclusively provide higher-quality, higher-cost insurance, and only investor-owned insurers would offer lower-quality, lower-cost policies. As this example shows, firms need not be investor-owned. Yet over time, in most industries, the successful large firms are investor- owned." Nevertheless, cooperatives have existed for hundreds of years, often even within the same industry as investor-owned firms.45 The following Part addresses why, exploring the impact of

41. HANsMANN, supm note 12, at 22-23; Alchian, supm note 38, at 216. 42. Daniel Schwarcz, Reevaluatng Standardized Insurance Policies, 78 U. Cm. L. REv. 1263, 1319-20 (2011). 43. HANSMANN, supm note 12, at 133-38. 44. Id at 1, 267; see also RIBSTEIN, supm note 24, at 2-3 (discussing the prevalence of "uncorporate" large-scale enterprise, including limited liability corporations and partnerships, in which suppliers of capital-investors-are generally the owners). 45. For example, Benjamin Franklin started a cooperatively owned insurance company in 1752, which continues today. HAROLD W WATERS, A CENTURY OF COMMITMENT: A HISTORY OF THE NATIONAL ASSOCIATION OF COMPANIES, 1895-1995, at 5 (1994); Company History, PHILA. CONTRIBuTIONsIP, http://www.contributionship.com/ history/index.html (last visited Mar. 22, 2014). Eighteenth-century Caribbean pirate crews are another example of early successful worker cooperatives. See genedlyPETERT.LEESON, THE INVISIBLE HOOK: THE HIDDEN EcoNoMICS OF PIRATES 23-44 (2009) (discussing the organization of these pirate crews). 910 TULANE LA WREVIEW [Vol. 88:899 cooperatives and considering their advantages and disadvantages relative to their investor-owned counterparts.

III. COOPERATIVES The scope and scale of cooperative enterprise are widespread and diverse both domestically and abroad. What is different about cooperative ownership versus investor ownership? How do these differences translate into different costs and benefits from ownership? This Part explores these questions. While not a complete survey of cooperative enterprise, it provides a good indication of cooperatives' relative strengths and weaknesses.

A. CooperativeFundamentals Although a precise definition of a cooperative is lacking, cooperatives in their most general sense are firms owned and controlled by a class of those who interact with the firm in a noninvestor relationship, such as by supplying inputs, working for it, or buying its products." This minimalistic definition is often expanded by the "seven cooperative principles" around which cooperatives generally operate: 1. Voluntary and Open Membership 2. Democratic Control by Members 3. Capital Contributed Equitably by Members 4. The Cooperative Is an Autonomous, Independent Organization Controlled by the Members 5. Education and Training Provided to Members 6. Cooperation Among Cooperatives 7. Concern for Community"

46. See CHARLES T AuITRY & ROLAND F. HALL, THE LAW OF COOPERATIVES 2 (2009); HANSMANN, supm note 12, at 21; see also Frost v. Corp. Comm'n of Okla., 278 U.S. 515, 546 (1929) (Brandeis, J., dissenting) ("[N]o one plan of organization is to be labeled as truly co- operative to the exclusion of others .... "). While states have cooperative-specific incorporation laws, cooperatives can be (and are) organized under a variety of incorporation laws, including C-corporation, limited liability corporation, and nonprofit corporation statutes. Deller et al., supra note 9, at 7. For representative examples of cooperative-specific laws, see 805 ILL. COMP. STAT. 310/1-27 (2013); N.Y. COOP. CORP. LAW §§ 1-134 (2013). 47. Co-Operative Identity Values & Pnnciples, INT'L CooP. ALLIANCE, http://ica. coop/en/whats-co-op/co-operative-identity-values-principles (last visited Mar. 22, 2014). These are the current manifestation of the seven cooperative operating principles, which have evolved over time. For a history, see Ann Hoyt, And Then There Were Seven: Cooperative Pnnciples Update4 UNIv. OF WIs. CTR. FOR COOPS., http://www.uwcc.wisc.edu/staff/hoyt/ 2014] THE PUZZLING LACK OF COOPERATIVES 911

Firms need not adopt all principles to obtain advantages of cooperatives. The key feature is ownership-the right to control and receive residual assets-by suppliers, workers, or customers, who can be termed the "patrons" of the firm.48 I return to this point at the end of this Part in assessing what attributes are essential for cooperatives' advantages, after critically examining areas of cooperative success. Like an investor-owned firm, cooperative owners supply equity.49 But unlike typical investor-owned firms, cooperative-equity investors wear two hats: their investor hat and their patron hat. To limit problems that could arise between conflicting investor and patron interests, cooperatives effectively remove the investor interest from the picture by eliminating returns on equity and requiring equal equity contributions from members." Once the returns on equity have been removed, cooperative owners share a common interest in maximizing their returns from the patron relationship, just as external investors in the investor-owned firm share a common desire to maximize the firm's residual earnings. These restraints on equity, however, can create costs for cooperatives that are examined in Part II.C below. Having outlined the basic nuts and bolts of how cooperatives are structured, I now transition to a discussion of how this makes cooperatives different from investor-owned firms. The following Subpart discusses the theory of when cooperatives will excel and princart.html (last visited Mar. 22, 2014) (originally published in COOPERATIVE GROCER, Jan.- Feb. 1996). The USDA defines a cooperative similarly as "a business owned and democratically controlled by the people who use its services and whose benefits are derived and distributed equitably on the basis of use." Donald A. Frederick, CooperativeInformation Report55, Co- ops 101: An Introduction to Cooperatives,U.S. DEP'T OF AGRIC., RURAL Div., http://www.rur dev.usda.gov/rbs/pub/cir55/cir55rpt.htm (last updated June 1997). In determining whether an organization qualifies for tax treatment, the IRS has adopted a similar set of principles. See Puget Sound Plywood, Inc. v. Comm'r, 44 T.C. 305, 308 (1965), acq. 1966-2 C.B. 3 (requir- ing subordination of capital interests, democratic control by patron-owners (right of control), and accrual of profits to patron-owners (right to residual assets)). On occasion, the IRS considers additional factors, such as if the cooperative has a minimum number of members. I.R.S. Priv. Ltr. Rul. 92-19-030 (May 8, 1992). 48. This nomenclature follows that first proposed by Henry Hansmann. Henry Hansmann, Ownershio ofthe Farm, 4 J.L. ECON. & ORG. 267, 270 (1988). 49. See HANSMANN, supra note 12, at 152-53. 50. See Jeffrey S. Royer, Cooperative Priiciplesand Equity Financing: A Critical Discussion, 7 J.AGRiC. COOPERATION 79, 82-83 (1992) (equity contributions); Bob Cropp et al., Equity Redemption Practices: A Study of Wisconsi Cooperatives,UNIV. OF Wis. CTR. FOR COOPS. (Sept. 1998), http://www.uwcc.wisc.edulinfo/equity_2.html (cooperative equity practices); Frederick, supra note 47 (same); Great Rivers Coop. of Se. Iowa v. Farmland Indus., Inc., 198 F.3d 685, 700 (8th Cir. 1999) ("[P]atrons of a cooperative ordinarily base their decisions to join a cooperative on the effectiveness of the services provided rather than on the risk inherent in an investment."). 912 TULANE LAW REVIEW [Vol. 88:899 surveys where and how cooperatives operate. This discussion shows when cooperatives are superior to investor-owned firms, setting the stage for the primary puzzle: when are cooperatives better, and why are they still uncommon?

B. Coopemtive Benefits At a basic level, all cooperatives accomplish vertical integration, coupling the firm with an upstream (supplier/producer) or downstream (consumer) process." Because of this vertical integration, the cooperative captures the profits ordinarily accruing to the upstream or downstream process." If this transfer of profits from one group to another were all cooperatives accomplished, there would be no compelling policy reason to support them since they would be merely welfare-transferring, not welfare-creating. However, in certain circum- stances, the unique attributes of cooperative ownership actually create benefits, justifying a preference for cooperatives under these conditions. An investor-owned firm must contract on the market with patrons for all patron-firm interactions beyond the provision of equity." In circumstances discussed below, this contracting relationship generates particularly high transaction costs. Because ownership by a group of patrons avoids having to contract with those patrons on the market by making them owners, cooperative ownership by patrons provides the benefit of avoiding these costs.54 Several types of imperfections can come up in market contracting with an investor-owned firm, but there are four that are particularly relevant." First, the firm could have market power over a group of patrons. Second, asymmetric information can exist between the firm and its patrons, where one party can use its private information to exploit the other. In these first two circumstances, ownership of the

51. See, e.g., KENNETH D. RUBLE, MEN TO REMEMBER: How 100,000 NEIGHBORS MADE HISTORY 25 (1947) (discussing this benefit in the case of the Land O'Lakes producer cooperative). 52. Seeid. 53. HANSMANN, supn note 12, at 53. 54. As a direct consequence of the First and Second Fundamental Welfare Theorems of economics, absent such market imperfections, ownership choice would be of no social consequence. It is precisely because of the imperfections that ownership matters. ANDREU MAS-COLELL ET AL., MICROECONOMIC THEORY 308-09 (1995). 55. While these are three instances where market failures commonly arise, they are not an exhaustive list. Behavioral psychology has developed several other ways in which markets can fail, due to various biases and cognitive limitations of its participants. Where appropriate, I discuss these additional limitations. 2014] THE PUZZLING LACK OF COOPERATIVES 913 firm by patrons acts as a commitment mechanism where the firm pledges not to exploit its patron-owners, since any gains from exploitation ultimately flow to the owners. Third, actions by the firm or its patrons could generate positive or negative externalities." Fourth, the mere act of ownership by patrons can induce desirable activity by those patrons that is not replicable through market contracting or through ownership by investors, as in worker ownership. These imperfections generate a broad array of situations where cooperative ownership has benefits over investor ownership. The following Subparts survey examples where cooperatives have demonstrated success. In doing so, the Subparts develop situations of market power, asymmetric information, provision of goods with positive externalities, and ownership motivation that cooperatives address. The Subparts structure these examples according to whether the cooperative's owners are producers who generate a product supplied to the cooperative, workers, or consumers of the cooperative's output. Examining cooperatives by owner type clearly exposes areas of unexploited cooperative advantage that motivate the discussion of Part IV

1. Producer Cooperatives I begin with producer cooperatives, where the owners of the cooperative are those producing an input in the cooperative's activities. Many producer cooperatives are agricultural cooperatives," where farmers supply inputs to the cooperative. The cooperative then sells these inputs, sometimes after processing them into a more refined form. Familiar examples of producer cooperatives include fixtures of agriculture such as the Sun-Maid Raisin cooperative, which sells raisins supplied by its owners," and Land O'Lakes, which turns milk from its owners into butter and cheese before selling it." In almost all cases, producer cooperatives form in response to actual or potential market power.' When producers face a buyer of their product who can dictate terms of trade (such as when buyers are

56. There is significant overlap between positive externality goods and public goods. I refer throughout this Article to the more general positive externality goods classification and take it to represent the case where the good provider or consumer cannot capture others' benefit from production or consumption of the good. 57. See Types of Coopemtives, 2012 INT'L YEAR OF CooPERATrIvEs, http://usa2Ol2. coop/about-co-ops/types (last visited Mar. 22, 2014). 58. See About Sun-Maig supranote 1. 59. See Our Story, suprd note 1. 60. See Types of Cooperatives,supra note 57. 914 TULANELA WREVIEW [Vol. 88:899 large and few but producer sellers are small and numerous), producers have much to gain by collectively taking over the buying activities, replacing the buyer with a cooperative owned by themselves that does not exercise its market power." As is the case whenever a restricted market is opened up to competition, these cooperatives increase social welfare.62 In markets with a monopsony buyer, unless government regulation constrains the activities of the buyer, the economies of scale inherent in these activities push toward an equilibrium where a single market buyer ultimately emerges." As long as this single buyer is investor-owned, it naturally seeks to wield its market power over suppliers to pursue maximum financial returns for its investor-owners, a pattern that has occurred repeatedly.' Government regulation can work in two ways: constraining firm size or constraining firm activity. Either solution imposes costs on society. Constraining firm size means economies of scale cannot be fully realized and the firm's costs are comparatively high, while constraining firm activity requires costly regulatory vigilance. An ideal solution is a single firm that commits not to exercise its market power as it realizes economies of scale. Producer cooperatives accomplish this goal. Because they are owned by suppliers-the parties over whom they could exercise market

61. Even if the resultant cooperative flexed its market-power muscle, monopsony profits (profits accruing to a buyer with market power who forces down input prices) previously captured by the monopsony purchaser instead go to the producers, solving the market-power problem. 62. See, e.g., MAS-COLELL ET AL., supm note 54, at 387-95. Cooperatives not only transfer the monopsonist's profits to the suppliers, but also expand purchases of supplies beyond the monopsonist's restricted level, which is an incremental social benefit that cooperative ownership provides. 63. See Yoav Kislev & Willis Peterson, Economies of Scale i Agicultu: A Reexanination ofthe Evidence, in 2 THE EcoNOMICS OF AGRICULTURE: PAPERS INHONOR OF D. GALE JOHNSON 156 (John M. Antle & Daniel A Sumner eds., 1996); HANSMANN, supra note 12, at 123-24, 141-42 (grain farmers); Types of Cooperatives,supra note 57 (market power of dairy buyers); RUBLE, supra note 51, at 29 (market power of butter buyers); Ted C. Schroeder, Economies of Scale and Scope for Aguicultual Supply and Marketing Cooperatives, 14 REv. AGRIC. EcoN. 93 (1992) (economies of scale for several agricultural buyers); JOHN A.C. HETHERINGTON, MUTUAL AND COOPERATIVE ENTERPRISES: AN ANALYSIS OF CUSTOMER-OWNED FIRMS INTHE UNITED STATES 129 (1991) (grain farmers). The majority of farming is still done at a small scale, with 96% of farms operated by families, farmer partnerships, or cooperatives. Andrew Zenk, Management Tip. Thoughtful Succession PlanningKeeps FamiliesFarming for Generations; RURAL COOPERATIVES, Sept./Oct. 2012, at 18. 64. For example, successful new investor-owned entrants to butter marketing repeatedly grew to a large size that enabled them to outcompete local providers, and once the local competitors closed, the remaining investor-owned firms engaged in monopsony pricing. RUBLE, supranote 51, at 105-08. 2014] THEPUZZLING LACK OF COOPERATIVES 915 power-these organizations can grow to capitalize fully on economies of scale while reducing the threat of harmfully wielding market power because doing so does not benefit its owners. As a consequence, society can have large-scale buyers that fully capture economies of scale without having to pay the expense of monitoring them to make sure they do not harmfully wield their market power." Although producer cooperatives arise primarily in response to market power, once established they may provide secondary benefits, such as research and development into improving the quality of owners' supplied inputs. Industries like farming benefit from continual reinvention and refining of technique, but if these improvements have positive externalities, they will be underprovided by the private market." For instance, the profit maximizer lacks full incentive to develop improvements for milk production if others easily learn of and replicate her technique." Nor do investor-owned buyers of producers' inputs have sufficient reason to develop and disseminate this information if it could spread to other producers.

65. If the cooperative grows large, however, it could instead serve as a coordination mechanism among suppliers to assemble and exercise their own market power. For example, dairy farmers might form a milk-processing cooperative and then attempt to use its resultant power over retail milk sales to drive up the retail market price of milk. Empirical evidence suggests this concern is far more academic than real. Even though certain agricultural cooperatives are given special antitrust treatment by the Capper-Volstead Act, 7 U.S.C. §§ 291-292 (2012), they generally are unable to assemble market power of their own. HANSMANN, supm note 12, at 126-29 (finding the only arguable exception to this principle to be fresh milk cooperatives, which operate in a regulatory regime particularly conducive to anticompetitive behavior); James G. Youde & Peter G. Helmberger, Marketing Coopemtives in the US: Membership Policies,Market Power and Antitrust Policy,48 J. FARM EcoN. 23, 33 (1966). In many respects this may be because most cooperatives are "open" to any new member that wishes to join, as in the Seven Cooperative Principles, so that monopoly profits quickly attract new producers to the cooperative, making it increasingly difficult to sustain above-market prices. Id But even those few producer cooperatives with "closed" member- ship that restricts new members from joining have been unsuccessful at assembling market power. HANSMANN, supra note 12, at 126-29. In large part this is because a closed cooperative that succeeds in raising prices through market power raises prices for farmers both in and out of the cooperative, encouraging out-of-cooperative farmers to expand operations and undermine the cooperative's market power. Id. To the extent the closed cooperative can differentiate its product from out-of-cooperative farmers', however, its attempt at market power could prove successful. So-called "new generation" cooperatives, which have gained limited popularity in certain agriculture processing markets, are a potential for this type of market power. See David Coltrain et al., Differences Between New Generation Coopeatives and Taditional Cooperatives, UNIV. OF WIS.-MADISON, CTR. FOR Coops. (Aug. 2000), http://www.uwcc.wisc.edu/info/newgen/cbb.pdf. 66. MAS-COLELL ET AL., supra note 54, at 361-62. 67. Although she would benefit from her own efficiency gains, she gains nothing from the others' improvements. See Amitai Aviram & Avishalom Tor, Overcoming Impedinents to Information Sharing, 55 ALA. L. REv. 231, 264-65 (2004) (discussing the general problem of information sharing when it benefits others). 916 TULANE LAW RE VIEW [Vol. 88:899

If producers collectively own research and development operations as a cooperative, however, the cooperative has more reason to develop improvements, even if knowledge of the technique can spread easily. The producers benefit-and the cooperative has reason to fund research-when the cooperative develops production improvements that are taught to producers for free. The better producers are at producing, the more the cooperative earns and the better off are all producer-owners who share in the cooperative's profits." Because of this, producer cooperatives" have been a fertile development ground of these positive externality improvements.o Often, those outside the cooperative ultimately adopt these improvements as well, making all better off." There are thus two clear areas where producer cooperatives succeed: where the buyer of supplied inputs has market power72 and where goods with positive externalities, like research, benefit producers." They generally form only to solve market power, however, rather than in response to any other market failures (information asymmetries, positive externalities, or motivation from ownership),74 suggesting an opportunity for expansion that I return to in Part IVC. 1.

68. In fact, this product development has reason to go both ways. Members benefit by informing other members of their own improvements. Ordinarily business rivals have no inducement to share information for which they cannot charge a fee; in fact, if sharing information makes rivals more productive and lowers the market price, there is a disincentive to sharing information. See generally id. (discussing this problem). When rivals own a cooperative, however, a rival's increased productivity translates into profits for all owners, providing inducement for information sharing even among rivals. See id at 267 (noting the potential for increased information sharing "in industries with a history of cooperation ... among rivals"). 69. This arm of the producer cooperative's activity could also be conceptualized as being that of a consumer cooperative, where the farmers are consumers of research and development. See mfra Part III. 70. See, e.g., RUBLE, supra note 51, at 25, 99, 175-76, 179-80 (discussing Land O'Lakes's role in developing improved farming practices, new ways to use farmer-supplied inputs, and new methods for transporting fragile produce). While agricultural cooperatives have more incentive than investor-owned firms to undertake this research, they will still provide a suboptimal amount (from the perspective of society at large) if the benefits spill over to others that are not owners of the cooperative. 71. See supa note 43 and accompanying text. 72. The similar presence of cooperatives in economies around the world as a check on buyer market power suggests the form's particular superiority at minimizing ownership costs in this situation. See, e.g., George WJ. Hendrikse, Screening, Competition and the Choice of the Cooperative as an OrganisationalForm, 49 J. AGRIC. EcoN. 202, 203 (1998) (describing supplier cooperatives in agricultural markets of other countries). 73. See Frederick,supra note 47. 74. Id. 2014] THE PUZZLING LACK OF COOPERATIVES 917

Next, I turn to worker cooperatives to develop some additional ways that cooperatives excel.

2. Worker Cooperatives Worker cooperatives constitute a relatively small percentage of total U.S. cooperative activity." The largest global example of a is the Mondragon cooperative of Spain, an associated group of cooperative and other organizations in disparate areas of finance, industry, retail, and technological innovation." Mondragon has proven remarkably successful, employing 83,000 workers to achieve annual revenues of £15 billion," with productivity levels exceeding those of its noncooperative counterparts " and extremely low failure rates of affiliated cooperatives." Worker cooperatives are widely present (on smaller scales than Mondragon) throughout other European countries,o and they also operate within the United States in the form of law firms, medical partnerships, and other professional corporations where regulation effectively requires the cooperative form." Other examples of worker cooperatives within the United States are rare. 2

75. Deller et al., supra note 9, at 11. 76. Tim Huet, News fm Mondragon, GRASSROOTS EcoN. ORG., http://www. geo.coop/archives/huet.htm (last visited Mar. 22, 2014) (noting Mondragon's partnerships with investor-owned firms); 2011 Annual Repori MONDRAGON 10, 70-97 (Dec. 31, 2011), http://www.mondragon-corporation.comn/p-content/themes/builder/informe-anual-2012/pdfen/ annual-report-201 1.pdf (listing both subsidiaries and affiliated cooperatives). 77. 2011AnnualRepor supra note 76, at 8. 78. HENK THOMAS & CHRIS LOGAN, MONDRAGON: AN ECONOMIC ANALYSIS 96-130 (1982). 79. GREGORY K. Dow, GOVERNING THE FIRM: WORKERS' CONTROL IN THEORY AND PRACTICE 61 (2003). For affiliated cooperatives that are closed, the workers must be reemployed within a thirty-mile radius. All in Tis Together: How Is the Co-Operative Model Cophg with the Recession?, ECONOMIST (Mar. 26, 2009), http://www.economist. com/node/13381546. 80. HANSMANN, supra note 12, at 103-05; John P. Bonin et al., Theoretical and Empical Studies of Producer Cooperatives: Will Ever the Tnn Meet? 31 J. ECON. LrrERATURE 1290 (1993). 81. HANSMANN, supra note 12, at 91. But see Schwartz, supra note 7, at 236-37 n.66 (contesting the classification of professional corporations as worker cooperatives, primarily because professional corporations usually include some nonmember workers). Nonmember workers are not exceptional occurrences in worker cooperatives; indeed, Mondragon, which Schwartz identifies as "[h]ands down, the most successful, long-lasting experience" with labor management, regularly employs nonmember workers and controls noncooperative subsidiaries. See id at 239. 82. Nevertheless, they encompass firms both large and small operating in a variety of industries. Georgeanne M. Artz & Younjun Kim, Business Ownership by Workers: Are Worker Cooperatives a Viable Option? 9 (Iowa State Univ. Dep't of Econ., Working Paper No. 11020, Nov. 2011), http://www.econ.iastate.edu/sites/default/files/publications/papers/p 918 TULANE LA WREVIEW [Vol. 88:899

Theorists have long questioned why worker cooperatives do not have more of a presence in the modem economy, because they could solve several market imperfections in the labor market." Professor Henry Hansmann aptly summarized the potential advantages of worker ownership as offering "improved employee productivity, avoidance of opportunism associated with employee lock-in, less strategic behavior in bargaining [between management and employees], better communication of employee preferences, and reduction in worker alienation." Some of these advantages mirror the discussion of producer cooperatives: because workers can develop firm-specific knowledge that makes switching employers costly, they can eliminate problems faced with monopsonist labor demand if they collectively own the firm. But worker ownership also solves other market-contracting problems. Both employers and employees have private information they may use to exploit the other. Strikes can be a highly visible manifestation of this asymmetric information problem that results when neither employers nor employees share complete information with the other. Further, worker ownership offers the potential advantage of workers who work harder and more efficiently as a result of this ownership. It is not just ownership's residual profit interest that motivates worker-owners." The actual right to control the firm and the status of being an owner appear to be powerful motivators of their own, from which workers derive nonfinancial benefits, driving them to greater performance than market compensation structures can achieve." It would be difficult" to make a compelling argument that

14575-2011-11-09.pdf (tabulating worker cooperatives affiliated with the United States Federation of Worker Cooperatives). 83. Schwartz, supra note 7, at 221 (recounting John Stuart Mill's prediction that worker-owned firms would outcompete investor-owned counterparts). 84. HANSMANN, supranote 12, at 74-75. 85. The rational worker concerned only with profit maximization would realize that even when she is an owner, her share of incremental firm revenue from working hard will generally exceed the costs of doing so, and she will slack on effort. 86. HANSMANN, supra note 12, at 69-70; Bonin et al., supra note 80, at 1297 (summarizing this evidence); Carla Dickstein, The Promise and Problems of Worker Cooperadves, 6 J. PLAN. LrrERATURE 16, 19-21 (1991) (same). Worker-owners report feeling more responsible for firm-wide profits and working harder than workers of investor-owned firms, showing nonfinancial motivations driving worker-owner behavior. See, e g., Edward S. Greenberg, ProducerCooperadves and Democratic Theory: The Case of the Plywood Firms in WORKER COOPERATIVES IN AMERICA 171, 184-86 (Robert Jackall & Henry M. Levin eds., 1984). Workers who perceive themselves as owners, rather than merely residual claimants, also have improved morale, motivation, and productivity. See Artz & Kim, suprd 2014] THE PUZZLING LACK OF COOPERATIVES 919 investor-owners usually have similar nonfinancial benefits from ownership.88 With the variety of market failures that worker cooperatives can overcome, it is surprising they are so rare. In addition to their methods of solving market power, managing information asymmetries, and providing the motivation of ownership in the ways just discussed, worker cooperatives could (but generally do not) also provide positive externality goods such as educating workers for their personal benefit. I return to this puzzle in Part IV Next, I address the final cooperative type: consumer cooperatives.

3. Consumer Cooperatives Consumer cooperatives constitute the bulk of U.S. cooperatives and operate in diverse areas of the economy." Like producer cooperatives, they solve problems of market power arising with interbank payment clearing,' utilities, independent grocers, social note 82, at 15; Andrew Pendleton & Andrew Robinson, Employee Stock Ownership, Involvement, and Productivity: An Interaction-BasedApproach, 64 INDus. & LAB. REL. REV. 3, 7 (2010); see also RANDY HODSON, DIGNITY AT WoRK 172-89 (2003) (finding workers who believe their exercise of voice will more likely influence operations to often exercise that voice more); Elizabeth A. Hoffmann, Exit and Voice: OrganizationalLoyalty and Dispute Resolution Strategies, 84 Soc. FORCES 2313 (2006) (finding workers of worker-owned cooperatives more inclined to exercise the costly "voice" option to improve an organization's operations, instead of merely exiting the firm). 87. In some cases, investors may take special pride in ownership of a company, such as investor-owners of a providing green energy. Whether their nonfinancial ownership benefits exceed those of workers owning the firm is an open question. And in many other circumstances, investors appear far more concerned with financial returns than with any nonfinancial utility they may derive from ownership. 88. Like producer cooperatives, worker cooperatives also have a theoretical downside. The concern is that workers irrationally overvalue the benefits from ownership and thereby form worker cooperatives too often, when they would be better off working for an investor-owned firm. Nittai K. Bergman & Dirk Jenter, Employee Sentiment and Stock Option Compensation, 84 J. FIN. EcoN. 667, 669 (2007) (finding workers overvalue ownership stakes in their employers); Shlomo Benartzi, Excessive Extrapolation and the Allocation of 401(k) Accounts to Company Stock 56 J. FIN. 1747, 1748-49 (2001) (same). Although many commentators think worker cooperatives do not form often enough, not that they form too often, the idea is important to keep in mind when considering potential policy reforms in Part V See, eg., Dow, supa note 79, at 41 (arguing that the current number of worker cooperatives is too low); Schwartz, supr note 7, at 283 (same). 89. These cooperatives are roughly 92% of all cooperatives by number and $450 billion in annual revenue. Deller et al., supra note 9, at 11. 90. The Federal Reserve processes approximately half of all electronic automated clearing house transactions, with the bulk of the remainder processed by a private organization cooperatively owned by its member banks, including Bank of America, Citibank, JPMorgan Chase, and Wells Fargo. See About TCIA CLEARINGHOUSE, https:// www.theclearinghouse.org/about-tch (last visited Mar. 22, 2014). 920 TULANELA WREVIEW [Vol. 88:899

clubs, life insurers, and housing." They also provide positive externality goods9 2 and, like worker cooperatives, can provide a nonfinancial ownership motivation such as with a cooperatively owned grocery store." But they are also particularly apt at solving information asymmetries. When customers cannot easily verify the quality of a good, a seller has reason to exploit the customer and sell low-quality goods at high prices. Regulation solves some of the problem, setting minimum-quality floors or mandating disclosure of various key attributes. Reputation or a customer's prior experience also constrains opportunism. Yet considerable gaps can remain between buyer and seller information. Property insurance companies, for example, have substantial leeway between what regulators require or what would hurt their reputation and how they treat their customers.94 Even consumer goods manufacturers can disguise the quality of their goods without losing significant business." If the seller is owned by its customers, this incentive is largely eliminated. The cooperative form acts as a commitment to refrain from exploiting the cooperative's customer-owners. Because the opportunity for seller opportunism arises in so many circumstances, so too do cooperatives. Cooperatives succeed in consumer retail,"

91. See HANSMANN, supm note 12, at 157-58, 169-70, 190, 199, 268-70. Purchasing cooperatives like health insurance purchasers and the United Foodservice Purchasing Co-Op also form to aggregate purchasers into a pool that can counteract a seller's market power. 92. Property insurance and agriculture cooperatives have been active here. Property insurance mutuals pioneered several fire-reduction methods and regularly engaged in educating their policyholders about loss prevention. JOHN BAINBRIDGE, BIOGRAPHY OF AN IDEA: THE STORY OF MUTUAL FIRE AND CASUALTY INSURANCE 129-30 (1952) (slow-burning floors and roofs); id. at 195-96 (public education); HEFLEBOWER, supra note 40, at 166 (general fire prevention). Indeed, the president of one mutual was so annoyingly active in promoting automatic sprinklers that he was told to "be sure to take a sprinkler with him when he died ... and went to where a sprinkler would help protect him." BAINBRIDGE, supra, at 131 (internal quotation marks omitted). For discussion of agriculture cooperative activities, see supranote 70 and accompanying text. 93. Marilyn Scholl, Membership Is Ownership. The CooperativeAdvantage, Coon. GROCER NETWORK (May-June 2008), http://www.cooperativegrocer.coop/articles/2009-01- 19/membership-ownership. 94. See Daniel Schwarcz, Diffemntial Compensationand the "Race to the Bottom "in ConsumerInsurnceMarkets, 15 CONN. INs. L.J. 723, 745 (2009). 95. This manufacturer opportunism drove the creation of REI, a consumer cooperative that sells recreational equipment. Andy Ryan, Who Owns REI. SEATTLE WKLY. NEws (Oct. 9, 2006, 12:00 AM), http://www.seattleweekly.com/2003-06-18/news/who-owns- rei/. 96. Id. (recreational equipment); HANSMANN, supra note 12, at 150-51 (agricultural supply purchasers). 2014] THE PUZZLIVG LACK OF COOPERATIVES 921 housing," life insurance," and property insurance,' all of which can involve information asymmetries. Similarly, when customers have private information that the seller cannot verify, customers have less reason to exploit the seller when they collectively own the seller. For this reason, credit unions, "housing,'o' and property insurance 02

97. With housing, owners have less incentive to keep the premises at a high level if doing so cannot be easily verified by tenants. HANSMANN, supm note 12, at 199. 98. A risk with life insurance is that the insurance company will not have sufficient assets to pay claims in the future-a risk that is extremely difficult for policyholders to cover by contract. Id. at 267-68. Modem solvency regulation mitigates this risk today, but leaves other risks intact, such as whether an insurer will deal honestly with policyholders or expeditiously handle claims. 99. BAINBRIDGE, supm note 92, at 154, 169-70. Historically, rural policyholders had great difficulty in identifying good policies from bad, which drove them to patronize mutuals exclusively. Id. at 169-70. As with life insurance, the worst property insurance opportunism has been curbed by regulation, but the potential for other abuses still remains, such as with the insurer's claims management practices. For instance, the three highest-rated homeowners insurers (Amica, USAA, and Auto-Owners Insurance) and the four highest automobile insurers (NJM Insurance, USAA, Amica, and Auto-Owners Insurance), as determined by Consumer Repors, are all mutuals, as is the highest-rated homeowners insurer, and the highest-rated automobile insurer in six of eight regions, as determined by J.D. Power. Protect Your Home, CONSUMER REP., Sept. 2012, at 24 (homeowners insurers); Save on Car Insurance, CONSUMER REP., Oct. 2010, at 34 (automobile insurers); Press Release, 2012 US. National Homeowners Insurance Study, J.D. POWER & Assocs. (Sept. 27, 2012), http:// www.jdpower.com/content/press-release/ujOQpsp/2012-u-s-national-homeowners-insurance- study.htm (homeowners insurers); Press Release, 2012 US. Auto Insurance Study, J.D. POWER & Assocs. (June 25, 2012), http://www.jdpower.com/content/press-release/Ne5o7yal 2012/u-s-auto-insurance.study.htm (automobile insurers). 100. Borrowers may be tempted to gamble loans on risky projects once receiving a loan. When the borrower is also an owner of the bank, her incentive to impose costs on the bank is reduced. HANSMANN, supranote 12, at 2 59-60. 101. Like landlords, tenants have reason to skimp on maintenance if the landlord cannot easily verify quality. Id at 199. 102. As with credit unions, mutual insurance companies allow the policyholder to commit to reducing future losses if the policyholder cares about co-owners' welfare. Early mutual property insurers provide anecdotal evidence for this contention. Patricia Born et al., OrganizationalForm and Insurance Company Performance: Stocks versus Mutuals, mnTHE ECONOMICS OF PROPERTY-CASUALTY INSURANCE 167, 172 (David F Bradford ed., 1998) (describing policyholders in property insurance mutuals declining to collect on claims for smaller losses); S.S. HUEBNER & KENNETH BLACK, JR., PROPERTY INSURANCE 507 (4th ed. 1957); VN. VALGREN, U.S. DEP'T OF AGRIC., BULLETIN No. 530: THE ORGANIZATION AND MANAGEMENT OF A FARMERS' MUTUAL FIRE INSURANCE COMPANY 3 (1917). This type of behavior is not confined to property insurers. See PATRICIA LLOYD WILLIAMS, THE CFC STORY: How AMERICA'S RURAL ELECTRIC COOPERATIVES INTRODUCED WALL STREET TO MAIN STREET 101 (1995) (describing customers of electric cooperatives who read their own meters to reduce the cooperative's expenses). Further, early insurers refused to insure individuals who were "moral hazards," meaning those of doubtful moral character. Tom Baker, On the Genealogy ofMom Hazarc( 75 TEX. L. REv 237, 252-55 (1996). Those without high moral character likely also could not be counted upon to care about reducing community-wide losses. 922 TULANELA WREVIEW [Vol. 88:899 cooperatives can have special advantages that their investor-owned counterparts cannot."'

4. Drawing It Together: What Matters for Cooperative Ownership Cooperatives' existing success shows their advantages can be significant and diverse. They arise in situations of market-contracting imperfections, where market power or information asymmetries persist, acting as a commitment mechanism that reduces opportunistic behavior among buyers and sellers. They also provide positive externality goods to their owners and facilitate the sharing of positive externality goods that owners independently develop. 10 Finally, cooperatives organize where cooperative owners get unique benefits from ownership, such as when worker-owners derive satisfaction from collectively owning the employer that carries over into their on-the-job performance." In all these cases, opening up ownership to a broad group of patrons creates these benefits. The following Table summarizes estimates of select cooperatives' current economic presence and shows where they have had the most success in solving these market failures.

103. Like producer cooperatives, consumer cooperatives present the troubling prospect of facilitating anticompetitive behavior by consumers, who might band together into a "purchasing cooperative" to reduce prices of purchased inputs below market levels. Purchasing cooperatives appear with relative frequency with investor-owned firms as the cooperative's owners. They have also arisen in health insurance, where individuals aggregate to exercise buying power. Elliot K. Wicks, Health Insurance Purhashig Cooperatives, COMMONWEALTH FuND (Nov. 11, 2002), http://www.commonwealthfund.org/Publications/ Issue-Briefs/2002/Nov/Health-Insurance-Purchasing-Cooperatives.aspx; About Us, Coop. NETWORK, http://www.cooperativenetwork.coop/wm/coopcare/web/coopcare.html (last visited Mar. 22, 2014). But like producer cooperatives, such concerns about cooperative market power may be more theory than reality. Suppliers to a buyer with monopsony power will shift to other methods of gainful employment, because the buyers are paid a below-competitive price. This diminishes the supply available to the buyer with monopsony power, who then has to raise prices to the remaining suppliers to obtain enough inputs, attenuating its monopsony power over longer time horizons. Cf V Bhaskar et al., Oligopsonyand MonopsonisticCompetion in Labor Markets; 16 J. EcoN. PERSP. 155, 156 (2002) (examining the persistence of monopsony power when suppliers cannot easily switch to other markets). Nevertheless, the potential for anticompetitive behavior exists, which should be kept in mind during the discussion of proposals for reform, infia Part V 104. See Scholl, supranote 93; Ryan, supranote 95. 105. See sources cited suprd notes 97-99. 106. SeeArtz & Kim, supra note 82, at 15. 2014] THE PUZZLING LACK OF COOPERATIVES 923

Table 1107

Type Number Gross Revenue Market Share (a mil) Farm 2,547 119,039 27% market share of supplies and Supply/Marketing of marketing Biofuels 39 9,405 Grocery 290 2,098 Arts and Crafts 305 94 Other Retail & Service 282 59,981 (hardware, coffee shops, book stores) Health Care 305 5,157 Childcare 1,096 161 Housing 9,471 - 7% ofnation's housing; 25% of multiunit housing Transportation 49 302 Education 390 753 Credit Unions 8,334 40,088 10% market share of household savings; 8.5% of consumer market loans; 10% of nonrevolving consumer market loans Insurance 1,497 187,343 17% of all life-related premiums written (36% of all ordinary life insurance premiums written); 27% of all property and casualty premiums written (39/ of homeowners' premiums written; 33% of private passenger auto premiums written) Cooperative Credit 147 84,575 Suppliers (Farm Credit: Cooperative Banks) Electric (G&T and 920 34,275 13% of customers; 5%of Distribution) generation; 6% of transmission Telephone 255 2,412 1 Water 3,350 2,170

Cooperatives' ability to solve these market failures results from patron- owners' dual entitlement to control the firm and to the firm's residual

107. Data except market share are from Deller et al., supm note 9. Information on market share is from Coopemdve Information Report 1: Faun Marketing, Supply and Service Coopemdve HistoricalStatistics, U.S. DEP'T OF AGRIC., RURAL Div. 79 (Aug. 2004), http://www.rurdev.usda.gov/rbs/pub/cirls26.pdf (farm supply and marketing); U.S. Dep't of Commerce, American Housing Survey for the United States: 2009, U.S. CENSUS BUREAU 1 (Mar. 2011), http://www.census.gov/prod/2011 pubs/hl50-09.pdf (housing); Monthly Credit Union Estimates, CREDIT UNION NAT'L Ass'N 9-10 (Jan. 2014), http://www.cuna.org/ Research-And-Strategy/Credit-Union-Data-And-Statistics/ (select Monthly Credit Union Estimates) (credit unions); calculations from BEST' S AGGREGATES & AVERAGES, LIFE/HEALTH, UNITED STATES & CANADA 5, 13 (2012) (life insurance); calculations from BEST'S AGGREGATES & AVERAGES, PROPERTY/CASUALTY, UNITED STATES & CANADA 146, 211 (2012) (property/casualty insurance); US. Co-Ops by the Numbers, NAT'L RURAL ELEC. Coop. ASS'N, http://www.nreca.coop/about-electric-cooperatives/co-op-facts-figures/u-s-co- ops-by-the-numbers/ (last visited Mar. 22, 2014) (electricity). 924 TULANE LA WREVIEW [Vol. 88:899 profits. These requirements are markedly broader than the seven cooperative principles outlined earlier.' Which, if any, of these principles are truly necessary for a cooperative's success at solving market failures? In addition to the rights of control and residual assets, a requirement can be added that residual assets be distributed to patron- owners proportional to their use of the cooperative. This requirement is important for several reasons. If one owner were entitled to an outsized portion of profits, the cooperative's potential to solve market failures begins to collapse. The owner who receives a disproportionate share of profits has reason to push the cooperative to exercise its market power or exploit information asymmetries over other patron- owners, since the dominant owner gains at their expense by doing so.'o That owner also benefits less by the cooperative's provision of positive externality goods to other patron-owners."' Moreover, as other patron- owners' profit interests shrink relative to their business with the cooperative, they have more reason to exploit any asymmetric information. Finally, other patron-owners' nonfinancial motivation from ownership will likely decrease as they see their efforts disproportionally accruing to the dominant owner."' When profits accrue disproportionately to use, the cooperative's commitment mechanism breaks down, making the firm resemble an investor-owned firm with additional costs from being a cooperative."' When the membership class includes most or all of the suppliers, workers, or customers, the cooperative's benefits also grow. Again, if the cooperative is owned by only some of its suppliers, workers, or customers, its ability to solve market failures diminishes. A cooperative owned by only half its workers, for example, still has reason to exercise its market power and information advantages over the remaining half, while it loses incentive to supply them with positive externality goods."'

108. See supr note 47 and accompanying text. 109. See, e.g., KATRINA V BERMAN, WORKER-OWNED PLYWOOD COMPANIEs: AN ECONOMIC ANALYSIs 111, 113 (1967) (identifying the problem of worker-owners' profit interest being disproportional to work performed as the driving failure of several worker cooperatives). 110. See id at I11 (describing some promoters' expected benefits that are unrelated to the provision of positive externality goods to other patron-owners). 111. See genemdly sources cited supra note 86 (discussing this advantage of cooperative ownership). 112. Seeinfia Part m.C (costs of cooperative form). 113. One can thus see that a sole proprietorship represents a "cooperative" with a restricted patron-owner class of one, with no benefits from the cooperative form. 2014] THE PUZZLING LACK OF COOPERATIVES 925

A cooperative can therefore be visualized along a continuum. At the extreme that maximizes the cooperative's potential benefits, a broad class of patron-owners shares profits proportional to use.' 14 As the patron-owner class narrows, or as a single owner gains a disproportionate share of profits, the cooperative's advantages diminish, although they may still remain. At the other extreme, with a single individual patron-owner who keeps all the firm's profits, the "cooperative's" ability to solve market failures has been lost, and what is left resembles an investor-owned firm. The Table and discussion reveal several instances of market failure that cooperatives have yet to address. Existing producer and consumer cooperatives on occasion expand to provide positive externality goods to their members, yet cooperatives do not form to offer these goods in the first instance, instead serving them as a by- product of other operations. Producer cooperatives outside agriculture are rare, despite seller market power that could favor their formation."' Nor do producer cooperatives solve information asymmetries. Furthermore, almost no worker cooperatives organize unless mandated by regulation, even though their promise of solving market-contracting imperfections is great."' And many noncooperative insurers and banks operate despite their cooperative counterparts' potential for resolving information asymmetries. Why have cooperatives not taken over every situation of market imperfection? Recall that there are not just benefits associated with any ownership form, but also costs. The conventional explanation, therefore, is that the costs of cooperative ownership (including the forgone benefits of not choosing investor ownership) outweigh benefits in these instances."' The next Subpart lays out these costs of cooperative ownership. It then rejects them as being an incomplete explanation, showing how these costs do not fully explain patterns in cooperative ownership. This sets the stage for the heart of the

114. I have not yet touched on voting rights. The seven cooperative principles require democratic control. As a practical matter, democratic control will ensure a single owner does not capture an outsized portion of profits. It need not be the only way of guaranteeing this outcome, however; absent a single majority patron-owner, voting rights proportional to use should achieve the same effect. Democratic control, however, may bring other benefits, particularly a maximization of ownership's nonfinancial motivational force. See generally sources cited supranote 86. 115. SeeHANsMANN, supranote 12, at 142; Deller et al., supm note 9, at 11. 116. SeeArtz & Kim, supra note 82, at 2. 117. See infia Part II.C. 926 TULANE LAW REVIEW [Vol. 88:899 discussion: cooperatives are comparatively rare because they are difficult to form.

C Cooperative Costs The costs of cooperative ownership relative to investor ownership fall broadly into two categories: higher financing costs and higher costs of decision making."' In both these areas, cooperatives' costs are expected to be higher than investor ownership's costs. First, all firms need financing, and cooperatives will have higher costs of financing their operations than investor-owned firms. This financing could come exclusively from market contracting for debt; however, as a practical matter, firms need equity."' Both cooperatives and investor-owned firms draw equity from their owners, but

118. Left out of this discussion is whether cooperatives' agency costs differ from those of investor-owned firms. Agency costs arise whenever an agent is not the sole beneficiary of her own efforts. Michael C. Jensen & William H. Meckling, Theory ofthe Fim: Managenal Behavior Agency Costs and Ownership Structure, 3 J. FIN. ECON. 305, 308-09 (1976). In firms, they arise when owners (principals) delegate tasks to management (agents). These costs are sometimes supposed to be more severe with cooperatives over investor-owned firms, since cooperatives lack the takeover threat that keeps investor-owned firms honest because cooperative ownership generally cannot be aggregated by a potential acquirer. Marc Schneiberg, OrganiadonalHeterogeneity and the Production ofNew Forms: Politics, Social Movements andMutual Companies n American FireInsurance, 1900-1930, in 19 RESEARCH IN THE SOCIOLOGY OF ORGANIZATIONS: SOCIAL STRUCTURE AND ORGANIZATIONS REVISITED 39, 51-52 (Michael Lounsbury & Marc J. Ventresca eds., 2002). Nevertheless, cooperative member-owners are largely free to terminate their relationship with the cooperative, making the threat of exit a constraint on management activity. See generallyALBERT O. HIRSCHMAN, ExIT, VOICE, AND LOYALTY: RESPONSES To DECLINE IN FIRMS, ORGANIZATIONS, AND STATES (1970) (broadly discussing exit, or the prospect of exit, as a deterrent to abuse by management); Henry Hansmann & Reinier Kraakman, Exit, Voice, and Liability: The Evolution of Organizational Law (June 2008) (on file with author) (discussing similar principles in the context of organizational reform specifically). Further, the special relationship many cooperative owners derive from ownership, combined with the important role of the cooperative's profits in many members' livelihood, can lead cooperative owners to monitor management more closely than owners of the investor-owned firm might. See sources cited supra note 86 (discussing nonfinancial rewards of ownership); Henry Hansmann, Coopelative Firms in Theory and Pmctice, 4 FINNISH J. BUS. ECON. 387, 397-98 (1999). But see J.A.C. Hetherington, Fact v Fiction: Who Owns Mutual Insurance Companies, 1969 Wis. L. REv 1068, 1083 (finding a low voting rate in election of directors by owners of large mutual insurers). Whether agency costs are therefore on balance more or less severe with cooperatives depends on firm-specific characteristics, making generalized conclusions inappropriate to draw. 119. Because equity is subordinate to debt, investor financing with equity provides a cushion for debt holders against bankruptcy that lowers borrowing costs. N. Pac. Ry. Co. v. Boyd, 228 U.S. 482, 504-05 (1913); 11 U.S.C. § 1129(b)(2)(B) (2012) (bankruptcy priority rules); Jensen & Meckling, supa note 118, at 333-43. 2014] THE PUZZLING LACK OF COOPERATIVES 927 cooperatives' costs of doing so are higher for two reasons.120 One, because cooperatives get equity only from their patrons, instead of the much broader investing public, the pool of potential equity contributors to cooperatives is smaller and necessarily raises capital costs. Two, a cooperative's pool of potential capital contributions is less diversified than is an investor-owned firm's, because both the patron's equity contribution and the patron's production, job, or consumption are tied to the cooperative's existence. Poor diversification necessarily increases costs of equity.12' In addition to higher capital costs, cooperatives also in theory have higher decision-making costs. Investor-owners generally share a unified goal: maximize the firm's financial profits.'22 The goal is specific and relatively straightforward to measure, making it easy for owners to decide on a course of action for their firm. Cooperative owners, however, can be more heterogeneous in their desires, reflecting heterogeneous patron relationships.'23 The course of action for the cooperative that most benefits one patron-owner might not be the one that most benefits another. This heterogeneity makes it more difficult for owners to agree on how to direct the firm. For example, Vanguard owners holding only international funds may want Vanguard to reduce associated fees with that fund to $0 and raise other funds' fees, while owners holding other funds would feel differently.'24 Getting these owners to agree on a common course may be complicated and costly. Therefore, by conventional arguments, the reason cooperatives succeed in many of the examples surveyed above is because the benefits from solving market failures are extensive with relatively small costs, either because the cooperative does not operate in a capital-intensive industry or because it takes steps to address owner heterogeneity.' Applying the evolutionary theory, the fact that these

120. Since a cooperative's equity costs will be higher, it will favor debt over equity compared to an equivalent investor-owned firm. Relatively lower equity, however, increases default risk, so debt costs are also higher. 121. See STEPHEN A. ROSS ETAL., CORPORATE FINANCE 246 (7th ed. 2005). 122. HANSMANN, supra note 12, at 62-63. 123. The focus here is on heterogeneous patron relationships, because cooperatives largely remove heterogeneity from the investor relationship. See sources cited supranote 50. 124. These conflicts can also come up if investor-owners share a patron relationship with a firm, such as if investor-owners of Fidelity also hold Fidelity mutual funds. But these relationships are a necessary feature of cooperatives, while they are optional for investor- owned firms. 125. A common method for reducing this heterogeneity for producer cooperatives is to have operations that use mostly a single input, while worker cooperatives may have 928 TULANE LA WREVIEW [Vol. 88:899 cooperatives succeed over the long term suggests that their benefits outweigh costs. Conventional explanations then go a step further: cooperatives do not succeed in unexploited areas because their costs would be greater than their incremental benefits. For example, customers do not collectively own car manufacturers because the resultant capital costs and decision-making difficulties would be high, and any benefits from avoided market power or information asymmetries or provision of positive externality goods would be small. The fact that cooperatives are not seen in these other industries over the long term is taken to be evidence that their costs outweigh benefits. It is this extension that is not appropriate.

D Problems with Extending the EvolutionaryTheory The problem with using the evolutionary theory as justification for cooperative success is that it requires one of two assumptions to be true. First, it must be the case that new firms choose whichever ownership form maximizes owners' ongoing benefits. In that circumstance, with competing types of firms present or equally able to be present, ownership types compete with each other, and the long- term dominance by one could accurately be explained as that form's ability to maximize benefits of ownership.' Or second, it must be the case that converting from one type of ownership to another can be done at low cost. In that circumstance, since a firm could convert to cooperative ownership when it is more efficient, if firms within a market systematically start and remain investor-owned, it again is evidence that investor ownership is superior. Both assumptions are violated, as Part IV will show. When that happens, applications of the evolutionary theory break down, because competing types of ownership are not on equal footing. Investor- owned firms can maintain a long-term presence in certain markets even when cooperatives would outcompete them, because barriers to cooperative formation deter cooperatives from ever entering.m' This

employee-owners who share a common job type and pay, and consumer cooperatives may sell a single type of good. Another way of managing owner heterogeneity is to delegate more decisions to management, potentially raising agency costs. See John Morley, The Separdon ofFunds and Manageis: A Theory ofInvestment Fund Structure and Regulaton, 123 YALE L.J. 1228 (2014) (discussing the case of Vanguard); see also discussion supm note 118. 126. See, e.g., Schwartz, supm note 7, at 223 (studying this in the worker-owned firm context). 127. SeekL'fiaPartIV 2014] THE PUZZLING LACK OF COOPERATIVES 929 explanation addresses several anomalies with existing patterns of cooperative operations, which I discuss in detail in Part IVC. When cooperatives are more difficult to form, the evolutionary theory still has explanatory power. Long-term observed cooperative success indicates not the only areas in which cooperative ownership is superior, but instead shows the areas where cooperatives either are so much more efficient that their benefits overcome their formation barriers or else have relatively low barriers to formation. The absence of cooperatives from particular markets, however, cannot be taken as conclusive evidence of their inferiority.

IV. BARRIERS TO COOPERATIVE FORMATION Analyses of relative efficiencies between cooperatives and investor-owned firms either assume that firms initially choose the form that maximizes ongoing benefits"' or that ownership can be switched between cooperative and investor-owned at low expense relative to potential savings.'29 In general, neither is the case. This Part argues that cooperatives are difficult to form, either in the first instance or via conversion of an existing firm, relative to investor-owned firms. Firms do not initially start as cooperatives because the entrepreneur must provide an unsubsidized public good, and conversion costs- particularly coordination difficulties-discourage most firms from converting to cooperatives. The implication of these difficulties is that cooperatives will not always appear, even when they are the efficient ownership form.

128. Almost without exception, literature on cooperatives assumes their existence exogenously and does not inquire into difficulties behind their formation. See Svend Albck & Christian Schultz, On the Relative Advantage of Cooperatives, 59 ECON. LETrERS 397 (1998); Jon Elster, From Here to There; Or If Coopeative Ownershp Is So Desiable, Why Are There So Few Cooperatives., i SocLIUsM 93, 108-09 (Ellen Frankel Paul et al. eds., 1989); Peter Helmberger & Sidney Hoos, CooperativeEnterpnse and Organization Theory, 44 J. FARM ECON. 275 (1962); Hendrikse, supra note 72; Richard J. Sexton, The Formation of Cooperatives: A Game-Theoretic Approach with Implications for Cooperative Finance, Decision Making, and Stability, 68 AM. J. AGRIC. EcON. 214 (1986); Berit Tennbakk, Markethig Cooperatives in Mired Duopolies, 46 J. AGRIC. EcON. 33 (1995); Oliver Hart & John Moore, Cooperatives vs. Outside Ownership (Nat'l Bureau of Econ. Research, Working Paper No. 6421, 1988), http://www.nber.org/papers/w6421; Patrick Herbst & Jens Prifer, Firms, Nonprofits, and Cooperatives: A Theory of Organizational Choice (CentER Discussion Paper No. 2007-07, 2011), http://papers.ssm.com/sol3/papers.cfn?abstractid= 734125. The lone exception that examines the difficulty in forming cooperatives at length is Schwartz, supra note 7, who restricts his attention to the particular case of worker cooperatives. 129. HANsMANN, supra note 12, at 45-46. Hansmann notes that switching costs are likely low relative to the value of the firm. However, the important comparison is switching costs relative to the savings from the new ownership form. 930 TULANE LAWREVIEW [Vol. 88:899

The following Subparts show why firms rarely start as or convert to cooperatives even when cooperative ownership would be more efficient. I then present empirical evidence consistent with this framework that cannot easily be explained by conventional accounts and then turn to implications for the shareholder primacy theory of corporate governance.

A. Entrepreneurs:Public Goods Problem For purposes of this discussion, recall first that in a cooperative, a class of patrons shares the firm's profits and control rights, with the former proportional to use and the latter often via a one-member, one- vote mechanism.' This sharing of ownership benefits drives the cooperative's ability to overcome the market failures of market power, information asymmetries, externality goods, and non-financial- ownership motivation. Unfortunately, these attributes are also the biggest impediments to cooperative formation by prospective patron- owners. Consider an entrepreneur with a new business idea. Suppose she has developed a new method of producing widgets, allowing her to sell them at a profit of $Pper widget. The upfront costs that must be spent before any widgets can be produced are $F perhaps consisting of the expense for setting up a widget factory. If she structures the enterprise as a sole proprietorship in which she keeps all the earnings, the entrepreneur could make $Pper unit in profits while risking $Ffor the factory. If instead the entrepreneur organized the firm as a successful cooperative, she shares the start-up factory expenses, but she also shares the profits. As long as the project is expected to have a positive payout so that $P is greater than $F the entrepreneur maximizes expected financial returns by maximizing her ownership stake. Key for the entrepreneur, however, is that she usually cannot take a disproportionate profit share if she starts the firm as a cooperative. This is because the cooperative's advantages accrue only as long as owners' profit shares are proportional to their use of the cooperative.'' If an entrepreneur organized a dairy-buying cooperative but kept half its profits despite accounting for only 1% of its inputs, she has reason to drive the cooperative to behave like an investor-owned firm that exploits other patron-owners.' Since the cooperative could not

130. See supra Part III.A. 131. See supra notes 109-111 and accompanying text. 132. See supra notes 109-113 and accompanying text. If the entrepreneur could not influence the cooperative's management, then the cooperative's commitment mechanism 2014] THE PUZZLING LACK OF COOPERATIVES 931 credibly commit to refrain from exploiting member-owners, the firm then functions like an investor-owned firm but with the disadvantages of a cooperative, explaining why so few cooperatives with disproportional profit distributions exist. Therefore, even if the cooperative promises higher total ongoing owner profits, the entrepreneur will not choose the form because her share of those profits is comparatively low. In this way, starting a cooperative is analogous to supplying a public good: the entrepreneur must share the profits from ownership among other member-owners."' However, initial entrepreneurs of investor-owned firms routinely are compensated for their entrepreneurial activity through sizable shares of the firm's future profits. Why is this effective for the investor-owned firm but not the cooperative? As a cooperative entrepreneur's share of the cooperative's profits grows, the entrepreneur increasingly benefits by having the cooperative exploit the patron relationship, undermining the cooperative's advantages. This arises because cooperative owners maximize the combination of their patron relationship and their owner relationship, and with a cooperative the owner profits can grow at the patron relationship's expense when they become decoupled through disproportionate profit might remain intact. But in that case, it is likely the cooperative owners would collectively vote to reduce the entrepreneur's profit share, which the entrepreneur would be powerless to block. See, eg., Great Rivers Coop. of Se. Iowa v. Farmland Indus., Inc., 198 F.3d 685, 692- 95 (8th Cir. 1999) (involving a situation where majority members voted to diminish the financial stake of older members). The entrepreneur, recognizing this probability, would never start the cooperative in the first place. When the entrepreneur's profit share and input share are the same, however, she no longer benefits by having the cooperative exploit its patron-owners. 133. Public goods are nonrivalrous (one person's use does not hurt another's) and nonexcludable (nonpaying users cannot be denied access). MAS-COLELL ET AL., supra note 54, at 359. The entrepreneur's activity is nonrivalrous, because the presence of co-owners does not decrease her utility (in fact, co-owners enhance the cooperative's profits). It is also nonexcludable, since cooperative ownership is generally open to new member-owners who usually do not compensate the original entrepreneur for her upfront legwork. The entrepreneur remains uncompensated because she cannot receive a disproportionate profit share as compensation for the reasons discussed above. In theory, the entrepreneur could receive a fixed wage or other compensation untethered to the cooperative's income for her efforts, assuming the cooperative was successful. This happens in limited circumstances. See BERMAN, supra note 109, at 110 (discussing compensation for some initial plywood cooperative organizers). But most of the time, organizers are never paid for their efforts. This could be because accurate compensation unrelated to the cooperative's future income is difficult to quantify at the formative stage. Or, perhaps entrepreneurs interested in compensation are usually better off starting an investor-owned firm and taking a higher profit share rather than being compensated by a low share plus a fixed wage that is not tied to the firm's success. See Robert Cropp, Starting a New Generation Cooperative, in A COOPERATIVE APPROACH To LOCAL EcoNOMIC DEVELOPMENT 25, 26 (Christopher D. Merrett & Norman Walzer eds., 2001); supra note 111 and accompanying text. 932 TULANELA WREVIEW [Vol. 88:899 shares. In contrast, the entrepreneur of an investor-owned firm has only a single relationship with the firm: that of an owner. Thus, as this entrepreneur's share of profits grows, the entrepreneur has less incentive for the firm to exploit its owners, because doing so increasingly harms the entrepreneur.134 Disproportionate profit shares thus act to reassure other owners of the investor-owned firm entrepreneur's legitimacy, while at the same time compensating the entrepreneur for her efforts. On the other hand, they act to undermine the cooperative entrepreneur's legitimacy.' If the profits and the value of the firm are the same whether it is organized as a cooperative or an investor-owned firm, it is not troubling when the cooperative does not organize. Consider the case, however, when there are incremental benefits from the cooperative through its ability to solve market-contracting failures. What if the cooperative now produces $P+Q of profit per unit (perhaps because producers supply particularly high-quality inputs, workers work harder, or consumers pay more to avoid exploitation), whereas the investor- owned firm produces only $Pper unit? From society's perspective, the cooperative form is preferable, creating an additional $ Q of profit and social welfare for each widget beyond the investor-owned firm. But because the profit-maximizing entrepreneur can receive a greater share of the investor-owned firm's profits, she will organize an investor- owned firm unless Qis very high relative to P If entrepreneurs fully internalized social welfare when starting a firm, there would be no issue. The entrepreneur would choose the cooperative form when it maximizes social welfare even if her personal financial returns were lower. But, in fact, almost all

134. Similarly, if the entrepreneur is also an employee compensated by a wage, the entrepreneur has more reason to maximize the firm's profits (at the expense of relaxed working conditions, perhaps) as her profit interest grows. 135. Others have argued that a collective action problem is what prevents most cooperatives from starting. See Schwartz, supm note 7, at 225. This problem was prominently identified by Mancur Olson as the reason why groups often fail to coordinate to achieve group-maximizing outcomes, since it is often individually rational for individuals to break from the group. MANCUR OLSON, THE LOGIC OF COLLECTIVE ACTION: PUBLIC GOODS AND THE THEORY OF GROuPs 48 (1971). While the costs of coordinating fellow cooperative owners may be nontrivial, see ifia notes 159-161 and accompanying text, they are not the main reason that cooperatives fail to form, since they go only to the entrepreneur's ability to share the start-up cost $Famong others. Even when the collective action costs are $0, as I have implicitly assumed in the example above, the entrepreneur will not choose the cooperative form because her share of profits will be small. 2014] THEPUZZLINGLACK OF COOPERATIVES 933 entrepreneurs seek to maximize only their personal financial profits."' The University of Michigan's Panel Study of Entrepreneurial Dynamics conducted a large-scale survey of entrepreneurs and documented, among other characteristics, entrepreneurs' reported motivations when starting a firm.'" Overwhelmingly, entrepreneurs reported personal desires for wealth and autonomy as their prime motivators, with society-oriented measures of pursuing a personal vision, status, respect, or concern for the community of distant secondary importance."' Even entrepreneurs starting organizations aimed at improving social welfare are driven by their financial self- interest." Why then do any cooperatives start at all? While there has been no systematic inquiry into the motivations behind cooperative entrepreneurs, history and the argument above show that an individual will form a cooperative if one of two factors weighs in their favor. First, the gains from cooperative ownership relative to investor ownership can be sufficiently high so that the entrepreneur profits more with cooperative ownership, even though she keeps a smaller share of the cooperative's profits.'40 In terms of the framework above, Q must be high relative to P Second, the entrepreneur could gain personal satisfaction from improving others' welfare in addition to her own. In that case, the entrepreneur accounts for social welfare rather than merely her personal financial returns when choosing an organizational form, so that she organizes a cooperative when it has higher total benefits than an investor-owned firm. Together, these factors account for the formation of many cooperatives now present. Several existing cooperatives promised

136. Paul D. Reynolds & Richard T. Curtin, Business Creation in the United States: Panel Study of Entwvpreneuial Dynamics II Aintial Assessment 4 FouND. & TRENDS ENTREPRENEURSHIP 155, 195-96 (2008). 13 7. Id. 138. Id These reports are consistent with most models of entrepreneurial activity, which assume firm creation is motivated by the prospect of financial profits. See, e.g., JOSEPH A. SCHUMPETER, THE THEORY OF EcoNOMIC DEVELOPMENT 128-38 (Redvers Opie trans., 1934); PA. Geroski, What Do We Know About Entry?, 13 INT'L J. INDUS. ORG. 421, 427-35 (1995) ("Virtually all of these presume that entry will be proportional to expected post-entry profits defined net of the costs of entry."). 139. See, e.g., Jeffrey G. York et al., Selective Incentives, Entrepreneurship,and Identity Toward a Behavioral Theory of Collective Action 16-17 (June 23, 2013) (unpublished manuscript) (on file with author) (discussing role of profits in motivating entrepreneurs of renewable energy); Edward L. Glaeser & Andrei Shleifer, Not-for-Profit Entepreneurs, 81 J. PUB. EcoN. 99 (2001) (developing a model to explain formation of nonprofits by profit-maximizing entrepreneurs). 140. See supm Part II.B. 934 TULANE LAWREVIEW [Vol. 88:899 higher personal returns to entrepreneurs than the entrepreneurs could achieve by starting an investor-owned firm, explaining their choice of the cooperative form. 4' For example, with many of the agricultural- producer cooperatives discussed above that organized in response to market power, the only viable option for new entrepreneurs was to start a cooperative.42 In these cases, P was close to $0 while Q was an appreciable positive number, so the only realistic way entrepreneurs could profit was to organize as a cooperative.143 Several consumer cooperatives also form for the same reason, particularly the large number of wholesale purchasing cooperatives that leverage purchasing power of individual members to generate their own market power." Other cooperatives have socially oriented entrepreneurs seeking to maximize the collective good at the expense of forgone personal financial returns. 14' Entrepreneurs who care about broader social welfare beyond their own personal financial returns might organize a cooperative even if they could earn more money by starting an investor-owned firm, because these entrepreneurs' value of social returns may outweigh their forgone financial return. 146 These individuals have organized several agriculture cooperatives, worker cooperatives, and insurers.147 While their impacts can be substantial, such entrepreneurs are rare.

141. RuBLE, supmnote 51, at 105-08. 142. Id 143. An entrepreneur organizing as an investor-owned firm faces the daunting prospect of outcompeting an incumbent monopsonist. The entrepreneur also would have to convince farmers that she would not exercise resulting monopsony power if she proved successful. Entrepreneurs historically have had considerable difficulty in credibly making this latter commitment, leading farmers to boycott entrant firms and making organizing as a new investor-owned firm unprofitable. See id. 144. An entrepreneur organizing such a business as an investor-owned firm faces the same difficulties as the entrepreneur discussed supra note 143. See generallyHEFLEBOWER, supra note 40, at 121-22 (purchasing cooperatives with investor-owned firms as members). 145. See Schwartz, supra note 7, at 274. 146. See PAuL C. LIGHT, THE SEARCH FOR SOCIAL ENTREPRENEURSHIP 1-11 (2008) (discussing the characteristics necessary for social entrepreneurs). 147. BAINBRIDGE, supra note 92, at 78 (property insurers); RuBLE, supra note 51, at 12-14 (describing the sacrifices made by organizer of butter cooperatives that were the precursor to Land O'Lakes); Cropp, supa note 133, at 26 (stressing the need in organizing cooperatives for a "champion [who] will make great sacrifices in committing the necessary time to providing leadership for the organizational process"); Ryan, supra note 95 (noting that REI's founder organized as a cooperative because he "wouldn't want to make money off [his] friends"); Schwartz, supma note 7, at 274-76 (worker cooperatives); Paul B. Trescott, John Bernard Tayler and the Development of Cooperativesin China, 1917-1945, 64 ANNALS PUB. & COOPERATIVE ECON. 209, 212 (1993) (various cooperatives throughout China). 2014] THEPUZZLING LACK OF COOPERATIVES 935

Still other cooperatives combine the two. Many cooperatives start along networks or community ties, such as cooperatives organizing around a common religion or employer,148 where individuals care about the group's welfare. These entrepreneurs might therefore be more inclined to select the cooperative form, and its member-owners might more often make sacrifices for the cooperative's good, raising Q.49 This model fits several mutual property insurance companies and credit unions.' Nevertheless, many instances in which cooperatives might be the efficient ownership form can fall through the considerable gaps among these situations. An efficient cooperative might never start because the entrepreneur's share of cooperative profits does not exceed her return from organizing as an investor-owned firm, because there is no entrepreneur who sufficiently values the collective good relative to her private good, or because the costs of assembling fellow members are too high. The next Subpart analyzes whether and how brokers play a role in filling these gaps.

B. BrokerDifficuldes At first blush, brokered formation of cooperatives has promise. After all, widely held investor-owned firms do not start out of the blue because coordinating more than a few co-owners is costly.' Instead, brokers are responsible for transitioning an investor-owned firm from the initial few owners to multiple investor-owners, and from one group

Many cooperatives also started in close-knit communities with common religious or other ties that fostered cooperative entrepreneurs, consistent with a norm of group welfare maximization. See Schneiberg,supo note 7, at 1418. 148. BAINBRIDGE, supra note 92, at 166-72; Schneiberg, supm note 7, at 1420-21. 149. Members sharing a bond may be less inclined to exploit informational advantages, increasing returns from cooperative ownership. See supm notes 95-103 and accompanying text. 150. See supranotes 98-100 and accompanying text. 151. The challenge of assembling a group together in pursuit of a goal can be daunting even when it is in each member's interest individually to do so. See generally OLSON, supM note 135, at 46 ("[C]osts of organization are an increasing function of the number of individuals in the group."). For instance, these costs are why property versus liability rules often matter in tort. Difficulties in coordinating a disparate group of individuals affected by a factory's pollution mean if they are protected by a liability right to be free from pollution, the factory may pollute even when doing so is socially undesirable, while if they have a property right, the factory might not. See R.H. Coase, The Problem ofSocial Cost 3 J.L. & EcoN. 1, 15-19 (1960). This holds even if the individuals would willingly pay to avoid the pollution. For an example of this problem in action, see Boomer v Atlantic Cement Co., 257 N.E.2d 870 (N.Y 1970). 936 TULANE LAW REVIEW [Vol. 88:899 of investor-owners to another.'52 When such a transfer promises efficiency gains, the broker can extract up to the entire gain as her fee while ensuring the new owners would still benefit from the transaction. Capturing much of this aggregate profit ensures the broker is willing to bear the expense of identifying and collecting new owners when new ownership is efficient. In principle, brokers should play a similar role in cooperative enterprise. They should be active in starting a firm and later selling it to existing patrons as a cooperative or in identifying and facilitating the transfer of an existing investor-owned firm to its patrons when the cooperative form is efficient. Since the cooperative entrepreneur has to share much of the resulting efficiency gains with co-owners, entrepreneurs organize too few efficient cooperatives. Because the broker can claim much or all of the resulting efficiency gains, brokers should be the ones starting cooperatives and converting existing firms to cooperatives. The broker thus would solve the problem of low financial returns that plague cooperative formation by entrepreneurs. In practice, however, the brokering process does not work with cooperatives. Evidence of their failure is abundantly clear. Apart from condominiums,' cooperatives do not start from the ground up with brokers' assistance.'54 And other than isolated cases of bankrupt or near bankrupt firms selling to a group of their patrons,'" and again

152. With transitions to broad investor ownership, the broker often buys the firm and then sells it to new investors. This is one function of private takeover organizations, which purchase firms and sell pieces to the organizations' investors, as well as investment banks and broker-dealers, which underwrite going-public transactions by buying an interest in the firm and then selling this interest to the public. See, e g., Samuel N. Allen, A Lawyers Guide to the Operation of Undewnting Syndicates, 26 NEw ENG. L. REv. 319, 320-21 (1991). With transitions to more closely held investor ownership, the broker may merely find new investor- owners who pay the old investor-owners directly, with the broker keeping efficiency gains in the form of a commission. See, eg., Anthony J. Bocchino & Samuel H. Solomon, What Juries Want To Hear: Methods for Developing Pensuasive Case Theory, 67 TENN. L. REv 543, 562 (2000) ("Business brokers are agents for buyers or sellers of businesses, and generally work on a commission basis."). 153. See, e.g., Michael H. Schill et al., The Condominium versus CooperativePuzzle: An Empical Analysis of Housmg i New York City, 36 J. LEGAL STuD. 275, 276 (2007); HANSMANN, supra note 12, at 218. Confusingly, both "condominiums" and "cooperatives" are cooperative methods of housing ownership, with the latter particularly popular in New York. Condominium residents collectively own their common structure and individually own the units, while residents of cooperatives collectively own both the structure and units. Schill et al., supra. 154. For example, in three prominent surveys of cooperative origins, brokers' potential for, or role in, starting a cooperative is never mentioned. See BAINBRIDGE, supM note 92; HEFLEBOWER, supra note 40; HETHERINGION, supranote 63. 155. In the early 1900s, management and investor owners initiated the conversion of select life insurers to customer ownership when these firms faced imminent bankruptcy or 2014] THE PUZZLING LACK OF COOPERATIVES 937 condominiums,' firms do not convert to cooperatives with broker assistance. Instead, most cooperatives-even large ones-form and convert upon the initiative of an individual entrepreneur of the type characterized above. This is in stark contrast to widely held investor- owned firms, which depend upon brokers to organize the ownership base. The precise reasons why brokering does not work with cooperatives deserve additional academic study. It is sufficient here to highlight its failure. However, I offer some initial speculation regarding their conspicuous absence. To some degree, there is a chicken and the egg problem. Because there have been so few conversions to cooperatives in the past, brokers often do not consider the possibility of converting a firm to a cooperative in the future.' If there were more conversions, then brokers might think more about doing them. But the statement just pushes the issue back a step-why were there not more conversions of cooperatives in the past? This question can be answered by looking at brokers' costs of effecting a cooperative conversion, and particularly the costs of assembling prospective cooperative owners. These costs usually appear to outweigh incremental gains brokers might make from converting firms to cooperatives instead of to investor-owned firms.'58 Assembling a group of the firm's patrons together to pursue a common goal can be costly, even when it is individually in each member's interest to do so.'" This challenge grows when fellow members must not only be assembled but also convinced that being in the group is a good idea. Cooperatives represent this heightened challenge. Since the form is unfamiliar to most, prospective patron- owners must first be educated about what a cooperative does, how it publicity disasters. Fletcher, supra note 30, at 22-23. Owners on occasion sell failing firms or firms in failing industries to customers or workers. BERMAN, supra note 109, at 117-21; HETHERINGTON, supra note 63, at 185; Alan Hyde & Craig Harnett Livingston, Employee Takeovers, 41 RUTGERS L. REv 1131, 1132 (1989). 156. For descriptions of the process of converting to condominiums with new tenant- owners, see Richard Chambers, Comment, Pusbed Out: A Call for InclusionaryHousing Programs imLocal Condombniun Conversion Legislation, 42 CAL. W L. REV. 355, 362-65 (2006) (describing the process in California); Eric I. Schneiderman, Cooperative and Condominium Conversion Handbook N.Y OFFICE OF ATIORNEY GEN. (2008), http://www. ag.ny.gov/sites/default/files/pdfs/publications/COOP/2OCONDO%20Conversion%20Handb ook.pdf (describing the process in New York). 157. This point was confirmed in conversations with individuals who lead analogous conversions among investor-owned firms. 158. See sources cited supr note 151. 159. See sources cited supr note 151. 938 TULANE LA WREVIEW [Vol. 88:899 succeeds, and that it can outcompete better-known, familiar, and existing investor ownership competitors.'" Assembling such a class will take time and effort, reducing the broker's expected returns."' Additionally, it is almost always unrealistic to find a new group of suppliers, workers, or customers to buy out an existing firm and complete the conversion to a cooperative because a wholesale replacement of patrons would be seriously disruptive and involve considerable costs. A successful conversion therefore requires convincing the existmng patrons that they value the firm most highly and, if any significant portion is resistant, that converting to broad cooperative ownership cannot succeed. Investors are numerous and fungible, however, so a conversion to investor ownership requires assembling only a small portion of the pool of willing investor-owners and is therefore less costly and more likely. These costs of coordinating cooperative owners explain the two areas where brokers have had some success converting investor-owned firms to cooperatives. The first of these is with conversions of apartment housing to cooperative tenant-owned condominiums. These conversions present a unique situation where new owner-tenants are readily substituted for existing tenants, so that the typical costs of coordinating existing patrons do not result.'62 The second area where brokered conversion of cooperatives has had some success is in buyouts of bankrupt or near bankrupt firms.'63 Whle existing patrons must still be coordinated in this situation, they may be much more receptive when the credible threat of firm dissolution looms overhead.6"

160. Schwartz, supanote 7, at 276-77. 161. See, eg., Cropp, supra note 133, at 26 (stressing the need in organizing cooperatives for a "champion [who] will make great sacrifices in committing the necessary time to providing leadership for the organizational process"). Note that these costs also stand in the way of an entrepreneur's organizing a new cooperative. See sources cited supm note 135. The entrepreneur can keep these costs low by starting small, beginning with only a few patrons, modest operations, and relatively low organizing costs. HEFLEBOWER, supm note 40, at 189-90. The entrepreneur can also organize along existing networks and relationships, which facilitates the initial coordination. See supra note 148 and accompanying text. Farmers were also often members of national organizations, further facilitating cooperative formation among them. See, eg., BAINBRIDGE, supra note 92, at 166-72; Schneiberg, supm note 7, at 1420-21 (discussing the role of the Grange and the Farmers Alliance). 162. See, eg., Chambers, supra note 156; Iver Peterson, The Anatomy of a Co-Op Conversion, N.Y. TIMES, Mar. 27, 1988, § 10, at 1 (describing the process behind a typical condominium deal). 163. See sources cited supm note 155. 164. These are not the only factors at work. Probabilities also favor the firm's converting to investor ownership. Several groups of investor-owners might buy the firm, but 2014] THE PUZZLING LACK OF COOPERATIVES 939

Thus, costs appear to cause brokers' failure to convert firms to cooperatives even when cooperatives offer the highest ongoing net benefits to owners. This means the task of forming and converting to cooperatives falls mainly to entrepreneurs. Unfortunately, as shown above, this reliance produces situations where cooperatives would be efficient if organized, yet the formative step is not taken.

C What Does This Thecry Explam? Conventional explanations use the evolutionary theory to say that industries with significant long-term cooperative presence are those instances (and only those instances) where cooperatives are efficient."' These explanations implicitly assume that firms choose the ownership form that maximizes owners' ongoing net benefits. As this Part has shown, this assumption is violated with respect to cooperatives. The following Subparts apply this conclusion to explain several empirical observations of cooperative behavior that cannot be explained by conventional applications of the evolutionary idea.

1. Lack of Cooperative Presence in High-Gains Areas The earlier discussion of cooperative benefits and costs shows that cooperatives should be most successful in markets where contracting costs with a group of patrons are high, capital requirements are low, and the patrons are relatively homogenous."' Yet several promising markets of this sort exist with no significant cooperative presence. For example, artists, literary authors, and musicians face a restricted group of buyers who routinely exercise their market power."' in practice a maximum of only three groups might convert the firm to a cooperative: its existing suppliers, workers, or customers. Each of these group's valuation might be randomly distributed around the firm's true value, because valuing the firm is imprecise, involving some subjectivity. In these circumstances, a group of investor-owners is likely to overvalue the firm most, because there are more groups of potential investor-owners than cooperative- owners. Thus, the firm is likely to convert to investor ownership even when it has equal value as a cooperative. By extension, as the spread in valuation imprecision increases, the finm will more likely convert to investor ownership even when its true value is greatest as a cooperative. 165. See HANsMANN, supm note 12, at 22-23. 166. See supm Parts m.B-C. The extent of homogeneity required is an open question, given examples of cooperative success despite heterogeneous owners such as REI or Vanguard. 167. DON THOMPSON, THE $12 MILION STUFFED SHARK: THE CuRious EcoNoMICs OF CONTEMPORARY ART 41-51 (2008) (describing the relationship between artists and dealers); Scott Timberg, Book Pubhshing Cnsis: Capitalism Il7s Cultumr, SALON (Nov. 10, 2012, 940 TULANE LAWREVIEW [Vol. 88:899

But almost no examples of producer cooperatives exist here despite the gains they might offer from solving market power.' Producer cooperatives also rarely organize to solve situations of asymmetric information, such as when suppliers have superior knowledge about the supply's quality.'" Health insurance presents instances of market power, both buyer and seller asymmetric information, and externality goods, but cooperative health insurers have no significant market share.' Research and development cooperatives among firms or large groups of individuals could solve the underprovision of goods with positive externalities, but these, too, generally do not form."' There is ample room for worker cooperatives in low-capital industries with worker homogeneity, such as taxi transportation or coffee shops, yet here, too, cooperatives rarely form despite their ability to solve all four types of market failures.' Comparing competing types of organizational forms shows that cooperatives should succeed in these industries with high gains and

5:00 PM), http://www.salon.com/2012/1 1/10/book..publishing-crisiscapitalismkillsculture/ (identifying limited publishers for literary authors and musicians). 168. There are a few examples of artist cooperatives that take over the role of dealers, showing the viability of this form, but to date it has not widely caught on. Deller et al., supm note 9, at 15-16. 169. Such might be the case, for example, if objective yardsticks inadequately capture the quality of inputs, as when disease is hard to detect in agricultural products or value can be determined only later in the manufacturing process, once inputs are intermingled. See RUBLE, supm note 51 (discussing how cooperative dairy farmers were encouraged to improve inputs along easily measurable dimensions only); A. Troccoli et al., Durum Wheat Quality: A MultidisciolinaryConcep4 32 J. CEREAL Sci. 99 (2000) (discussing measurable dimensions of wheat quality). 170. Cooperative health insurers' market share is approximately 1%. Carmen DeNavas-Walt, Bernadette D. Proctor & Jessica C. Smith, Income, Poverty and Health Insurance Coverage hi the United States: 2010, U.S. CENSUS BUREAU 23 (Sept. 2011), http://www.census.gov/prod/2011pubs/p60-239.pdf (stating that approximately 256 million Americans have health insurance); Harris Meyer, Feds Jump-StartHealth Insurance Co-Ops with Loans, KAISER HEALTH NEWs, http://www.kaiserhealthnews.org/stories/2012/february/ 21/health-coop-cooperatives-federal-loans.aspx (last updated Feb. 22, 2012, 1:25 PM) (noting that cooperative health insurers cover two million people). 171. This is despite federal policy recognizing an antitrust exemption for these activities. Stephen Martin, Public Policies Towards Cooperation in Research and Develop- men; in COMPETITION POLICY INTHE GLOBAL EcoNOMY 245, 267-69 (Leonard Waverman, William S. Comanor & Akira Goto eds., 1997). When a cooperative undertakes such research and development, it is only in the context of having organized for another purpose, such as agricultural marketing. See supra notes 66-68 and accompanying text. But see Alorie Gilbert, Newsmaker: The CIOs Strike Back CNET (Apr. 29, 2004, 4:00 AM), http://news.cnet.com/2008-1001-5201835.html (describing the organization of a software research cooperative). 172. Although taxi cooperatives are common in other countries, particularly Sweden and Israel, they constitute only a small portion of U.S. taxi operations. HANSMANN, supra note 12, at 1760 (foreign cooperatives); Deller et al., supranote 9, at 33-34. 2014] THE PUZZLING LACK OF COOPERATIVES 941 low costs. Why have they not? A lack of financial return to the entrepreneur who chooses the cooperative form and the ineffectiveness of brokers provide the answer that conventional explanations cannot.

2. Strong Performance of Existing Cooperatives Although not as comprehensive as one might hope, the limited empirical studies on cooperative ownership versus investor ownership performance generally suggest cooperatives have lower failure rates than comparable investor-owned rivals, after controlling for a variety of factors such as firm size, age, and industry."' Studies also find that cooperatives broadly have higher measures of productivity than comparable investor-owned firms in industries as diverse as property insurance to credit unions, again after controlling for relevant factors.174 While the evidence is not conclusive, it is consistent with barriers to cooperative ownership that filter out inframarginal cooperatives and favor the formation of only the strongest and most productive cooperatives. If cooperatives rarely organize because of the problems discussed above, only the exceptional cooperative will be able to overcome these barriers. In many of these cases, this will be because the cooperative offers such significant efficiency gains over investor

173. This finding is most robust (and most studied) with respect to worker cooperatives. See Dow, supranote 79, at 226-27 (collecting studies); Artz & Kim, suple note 82, at 19 (collecting additional studies). Although these studies control for a variety of factors, they are not perfect. Selection effects could be an issue, whereby only individuals highly motivated by the cooperative form choose to become owner-members of the cooperative. Even accounting for selection effects, however, these findings suggest unexploited cooperative opportunities unless it is the case both that cooperatives do not attract unmotivated owner-members who capitalize on the efforts of the more motivated, and that the pool of potential motivated owner-members has already been entirely exhausted by existing cooperatives. 174. See, e.g., Chris Doucouliagos, Worker Partic4pationand Productivity in Labor- Managedand PartcipatoryCapitalist Fims: A Meta-Analysis 49 INDus. & LAB. REL. REV. 58, 73-74 (1995) (finding productivity positively associated with worker ownership); Dow, supranote 79, at 182-84 (collecting several studies on worker ownership); Joseph R. Blasi et al., Cxatng a Bigger Pie?: The Effects ofEmployee Owneshi, Profit Shating,and Stock Options on Workplace Performance, in SHARED CAPrALiSM AT Woluc 139, 160 (Douglas L. Kruse et al. eds., 2010); Saoia Arando et al., Efficiency in Employee-Owned Enterprises: An Economic Case Study ofMondagon (IZA, Discussion Paper No. 5711, 2011), http://papers. ssrn.com/sol3/papers.cftn?abstractid=1849466. But see Bonin et al., supra note 80, at 1307 (synthesizing studies that show worker ownership is positively correlated with productivity in some circumstances but not others). Cooperatives are also found to be more productive in some industry-specific comparisons. See Born et al., supra note 102, at 191 (insurers); Are Mutual Insurers an Endangered Species? 3 (Swiss Re, Sigma No. 4, 1999) (insurers); Surendra K. Kaushik & Raymond H. Lopez, Profitability of Credit Unions, Commercial Banks and Savings Banks: A Comparative Analysis, 40 AM. EcoNOMIST 66, 76 (1996) (credit unions). 942 TOLANELA WRE VIEW [Vol. 88:899 ownership that the entrepreneur still organizes the firm even though she receives only a share of the gains."' Cooperatives with smaller efficiency gains do not get started. If this were the case, cooperatives as a group would exhibit lower failure rates and higher productivity measures, precisely what the empirical findings suggest."' But if cooperatives always started when efficient, their performance as a group should converge to that of investor-owned firms. To be sure, cooperatives do not form only when they offer efficiencies; just as with investor-owned firms, cooperatives can start when they are ultimately less productive and fail. But the evidence that cooperatives as a class are more efficient than investor-owned firms is consistent with barriers to cooperative formation.

3. Persistence of Cooperatives Once Formative Influence Is Removed Several agriculture and insurance cooperatives organized at a time when lax regulation led to market contracting problems that made cooperative ownership attractive."' Because of today's more rigorous antitrust enforcement and heightened regulation of insurance companies, these cooperative advantages have diminished."' Yet agriculture and property insurance cooperatives that formed in these historical times continue and expand their operations, often with efficiencies as good as, or better than, investor-owned competitors."' Only if there were barriers to initial cooperative formation could a significant portion of cooperatives' relative advantage be later eliminated and have the firm remain efficient and even thrive. That this trend persists over the long term suggests these companies are not merely the last vestiges of historical circumstances. Indeed, new cooperatives in these areas still start, although for property insurance (for which comprehensive data are available) the formation rate has slowed, which could be expected if the form still offers real, but diminished, efficiencies.'

175. See supranotes 139-144 and accompanying text. 176. See sources cited supm note 174. 177. HANSMANN, supranote 12, at 124-25, 271-72, 284-85. 178. Antitrust enforcement reduces the presence of monopolies between buyers and sellers, while regulation of insurance companies reduces the companies' ability to exploit asymmetric information and market power. 179. This evidence is most robust with property insurers. See, e.g., Born et al., supra note 102, at 19 1; Ar MutualInsurers an EndangeredSpecies?,supra note 174, at 3. 180. Analysis of A.M. Best data shows 32 surviving cooperative property/casualty insurers founded from 2000 through 2010 compared to 474 investor-owned property/casualty 2014] THE PUZZLING LACK OF COOPERATIVES 943

However, with life insurance, investor-owned firms have become more prominent, with several cooperative insurers converting to investor ownership. "' Regulation's undermining of cooperative advantages has been particularly impactful here, as has been the increase in costs from cooperative insurers' restricted access to capital.182 If enough of a cooperative's advantages are removed at the same time as costs of cooperative ownership rise, it will become inefficient, even if it originally had significant benefits. Such is apparently the case here.' If there were no barriers to cooperative formation, a significant portion of cooperatives would be only slightly more efficient than their investor-owned competitors. Thus, cooperatives as a group should largely exit the market or convert to investor ownership over the long term when a large portion of their advantage is removed, since they would then be less efficient than investor-owned competitor firms. But this often does not occur. The continuing existence of most cooperatives in these circumstances suggests they originally required exceptional benefits sufficient to overcome the barriers to formation.

D AppropnatelyApplying the Evolutionary Theory Combining theory, observation, and evidence shows that areas of demonstrated cooperative success cannot rightly be assumed to be the only areas where cooperatives are comparatively efficient. Dispropor- tionate barriers to cooperative formation, relative to investor ownership, prevent cooperatives from achieving dominance in or even entering markets where they are the superior form of ownership. Conventional explanations, however, do apply. Survivorship shows those markets where cooperatives were able to overcome these barriers, because of high returns to cooperatives, community-oriented insurers. This rate of cooperative vs. investor-owned creation is far less than their respective existing market shares, suggesting a modern decrease in their formation rate. See supra Table 1. For life insurance, only two surviving cooperative life/health insurers were started from 2000 through 2010 compared to 199 investor-owned life/health insurers. This rate is also far less than their respective market shares. See supm Table 1. 181. Am MutualInsures an EndangewdSpecies?, supra note 174. 182. HANSMANN, supranote 12, at 271-75. 183. Note that the increase of investor-owned firms at cooperatives' expense shows both the speed at which market pressures select the efficient ownership form when different types are already present and the success of brokers in promoting efficient investor ownership-the evolutionary theory at work. Yet the evolutionary theory is applicable here only because cooperatives and investor-owned firms were simultaneously present and because competitive forces pushed toward investor ownership, where starting and brokering firms are not difficult. 944 TULANE LA WREVIEW [Vol. 88:899 entrepreneurs, or low costs of assembling prospective patron-owners.'" By extension, there is room for cooperative growth beyond those industries where they currently appear.

E. Implicadonsfor ShareholderPrimacy The shareholder primacy model of corporate governance says that management should respond exclusively to the economic interests of shareholders.' Its proponents point to the lack of widespread cooperatives and other ownership forms with diverse owners as evidence that the ongoing costs-particularly from difficulties in collective decision making and the resulting management agency costs-of competing corporate governance methods, such as a stakeholder model, make them undesirable.' A shareholder primacy model for corporate governance minimizes these costs and promotes efficient organizations."' Many of these principles have become embodied in corporate law today.' The shareholder primacy model is not without its critics, who argue that management should also address the interests of other stakeholders-such as suppliers, workers, customers, or the community.' These arguments have recently gained traction in social enterprise, where they have driven states'-including Delaware's- consideration or adoption of new corporate forms including low-profit limited liability companies (L3Cs) and benefit corporations. 1" Stakeholder advocates' critics must grapple with two related problems: why are few firms owned by stakeholders if doing so would maximize the firm's returns, and would a stakeholder model result in

184. See supra Part IVC. 185. Henry Hansmann & Reinier Kraakman, The End offlstory for CorporteLaw, 89 GEO. L.J. 439 (2001). 186. Seeid. 187. Seeid.at449. 188. See, eg., eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1, 46 (Del. Ch. 2010) (finding that principals of Craigslist violated corporate law duties by failing to pursue profit-maximizing opportunities for shareholders). See generallyEdward B. Rock, Adapting to the New Shareholder-CentricReality, 161 U. PA. L. REv. 1907 (2013) (describing this change in a corporate law paradigm). 189. Lynn A. Stout, Response, The Toxic Side Effects ofShareholderPrinacy, 161 U. PA. L. RE. 2003, 2012-19 (2013). See generally LYNN STOUT, THE SHAREHOLDER VALUE MYTH (2012) (developing these arguments at length); KENT GREENFIELD, THE FAILURE OF CORPORATE LAW: FUNDAMENTAL FLAWS AND PROGREsSIVE POssIBLmEs (2006) (arguing that firms should account for stakeholder interests). 190. Dana Brakman Reiser, Theoizing Forms for Social Enterprise, 62 EMORY L.J. 681, 683 (2013). These developments are not without their critics. See, eg., Brian D. Galle, SocialEnterprise: Who Needs It. 54 B.C. L. RE. 2025 (2013). 2014] THE PUZZLING LACK OF COOPERATIVES 945 unmanageable decision-making costs or agency costs?"' This Article supports the stakeholder model in both respects. First, stakeholder- owned firms like cooperatives might be rare because of barriers to formation, rather than because of an inability to maximize welfare. Second, these formation difficulties, rather than collective decision- making costs and agency costs, could drive the lack of stakeholder- owned firms like cooperatives. In that case, while these collective decision-making and agency costs should not be ignored, they need be neither insurmountable nor the primary reason cooperatives are scarce, meaning the perceived benefits of shareholder primacy may be overstated.

E Summary As was noted at the outset of this Article, ownership structure is important because it affects all attributes of a firm's process, from the techniques used by its suppliers, to the way it treats its workers, to the quality of the products it produces for its consumers, to the prices that are charged, to the need for costly regulation and oversight.' Society's goal should therefore be that different methods of ownership are chosen based solely on relative efficiencies, not on barriers to formation. When cooperatives are more efficient, investor ownership should not dominate merely because cooperatives are necessarily more difficult to organize. But when cooperatives are inefficient, entre- preneurs should choose an alternative form. In ideal circumstances, cooperative ownership would be chosen in those circumstances (and only those circumstances) where the net benefits from cooperative ownership exceed those of other ownership forms. Removing the barriers that inhibit cooperatives from forming is an important step toward achieving this goal. Part V considers how one could begin.

V. SUBSIDIZING COOPERATIVES If cooperatives are in many cases the better form of ownership, but face disproportional difficulty in starting, society as a whole-not just patron-owners---could benefit from more cooperatives in appropriate circumstances. Subparts A through D develop ways for fostering the creation of cooperatives. Subpart E then applies these

191. See Lynn A. Stout, Badand Not-So-BadArguments for ShareholderPrknacy, 75 S. CAL. L. REv. 1189, 1199-1201 (2002). 192. See supm Part III. 946 TULANE LA WREVIEW [Vol. 88:899 ideas to Congress's new subsidization of health insurance cooperatives as part of the Affordable Care Act.

A. Genenl Tax or GrantIncentives The tax system has long been a tool for incentivizing socially desirable activities. Homeownership receives a tax subsidy arguably because of the positive spillovers it has on society.'" Nonprofits are given a host of tax advantages when they provide social benefits. 94 The tax code's potential to incentivize cooperatives is no different. In important respects, all cooperatives have the same problems deterring their formation. Individual entrepreneurs lack financial incentives to start cooperatives or convert firms to cooperatives, prospective patron familiarity with cooperatives is low, and brokering processes are scarce and undeveloped. These common problems suggest the possibility of a common solution through the tax code. Before considering such a solution, it is worth briefly highlighting the similarities between this problem and the barriers to formation that nonprofits face. As with cooperatives, nonprofit entre- preneurs confront the prospect of low personal financial returns, because both cooperatives and nonprofits improve welfare in ways the entrepreneur cannot capture herself. '" And brokered nonprofit transactions are similarly undeveloped.'96 Nonprofits receive subsidies from the tax code when these welfare improvements fall into enumerated charitable categories roughly coinciding with providing goods or services with positive extemalities.'" These subsidies encourage nonprofits' formation and ongoing activities separately. Donations and tax-exempt bond

193. See, e.g., Daniel Aaronson, A Note on the Benefits of Homeownershi, 47 J. URB. EcoN. 356, 357-58 (2000) (exploring these positive spillovers). The subsidy arises through the nontaxation of homeowners' imputed rental income. See genem/ly LEE ANNE FENNELL, THE UNBOUNDED HoME: PROPERTY VALUES BEYOND PROPERTY LINES 157-58 (2009) (discussing innovative subsidies to effect certain patterns of land use). 194. Exempt nonprofits do not have to pay federal income tax on their net earnings related to their exempt purpose, while exempt nonprofits that qualify for "charitable" status receive additional benefits, including deductions to donors for their gifts, eligibility for grants from private foundations, the ability to issue tax-exempt bonds, and usually, state property tax exemptions. Peter Molk, Reforming Nonprofit Exemption Requirements 17 FORDHAM J. CORP. & FIN. L. 475, 482-83, 486-87 (2012). 195. Nonprofits are prohibited from distributing profits to controlling individuals, so that just as with the cooperative, a nonprofit entrepreneur must share profits with other members or society at large. See Hansmann, supm note 20, at 838 (identifying the nondistribution constraint). 196. HANSMANN, supranote 12, at 294. 197. See Molk, supra note 194, at 488-89. 2014] THE PUZZLING LACK OF COOPERATIVES 947 issuances help nonprofits start, and their income and state property tax exemptions encourage ongoing activities. When these tax subsidies are not enough, the federal government also has given direct grants to encourage exempt nonprofits to form.' These principles can be applied to cooperatives. A cooperative entrepreneur, like a nonprofit entrepreneur, produces positive externalities. Recognizing that the nature of these positive externalities varies between exempt charitable nonprofits and cooperatives, I can nevertheless borrow ideas from nonprofit subsidization and apply them to cooperatives. The following two Subparts consider possibilities taken from nonprofits for encouraging initial cooperative formation.

1. Encouraging Initial Formation Through the Tax Code This Article has shown that barriers inhibit the spread of efficient cooperatives. There are several ways to address these barriers. One appealing method decreases other cooperative costs, such as their cost of capital. Reducing this cost could help counteract cooperatives' formation difficulty. One way of doing so would be to enable cooperatives to issue tax-exempt bonds. This would lessen cooperatives' debt costs and decrease the amount of equity they need. Lower equity requirements make more potential patron-owners able to afford membership and increase cooperatives' expected returns. Both make it more likely the cooperative will start in the first place, the first by lowering formation costs and the second by increasing cooperative profitability and attractiveness to entrepreneurs. By limiting cooperatives' ability to issue such bonds to the formation stage only (perhaps making them available only during the first year of a cooperative's existence), this subsidy is assured of applying only to cooperative formations, which is where the barrier lies. Tax-exempt bonds also increase the likelihood of converting an existing firm to cooperative ownership, with or without broker assistance. Converting a successful firm to a cooperative requires buying out the existing owners' equity, which for a successful firm can impose onerous buy-in requirements on new patron-owners.'" By

198. For a general listing of government grants encouraging a variety of activities, see Home, GRANTs.GOv, http://www.grants.gov/web/grants/home.html (last visited Mar. 22, 2014). 199. Perhaps for this reason, Congress has created tax advantages to facilitate worker buyouts of existing investor-owned firms through Employee Stock Ownership Plans 948 TEANE LA WREVIEW [Vol. 88:899 making debt financing more attractive, restructurings can substitute more debt in place of equity and again open membership to more prospective patron-owners. Tax-exempt bonds need not be the exclusive tax-based method of subsidizing cooperative formation. In addition to (or in lieu of) tax- exempt bonds, another possibility would be to give cooperative members a deferral on income tax on the first $Xof a cooperative's profits2" retained by the cooperative for future operations.20' Currently, owners of cooperatives realize phantom income, where they pay individual-level tax on their share of the firm's profits today, even when these profits are not immediately distributed to owners and are instead retained by the firm to finance future operations.202 Ensuring that owners receive sufficient distributions to cover this burden is a limitation on cooperatives' ability to retain earnings and finance initial operations. As with tax-exempt bonds, limiting the deferral to the cooperative's early operations ensures the subsidy applies only to the cooperative's formative period. During this formative period, if retained earnings were not taxable to cooperative owners until ultimately distributed as profits, the result is an effective way of providing cooperatives desired preferential treatment. Greater expected earnings over a cooperative's lifetime make the cooperative more attractive to entrepreneurs, spurring their initial creation. And providing this deferral in the early years of

(ESOPs). One downside, however, is that the requirements of new-worker ownership are minimal, making many of these transactions a situation where investor-owners maintain control over the firm while reaping the ESOP tax advantages. How To Establish an ESOP, ESOP, http://www.esopassociation.org/explore/how-esops-work/learn-about-esops (last visited Mar. 22, 2014) (discussing tax advantages of ESOPs); HANSMANN, supra note 12, at 105-08 (noting lack of worker control in many ESOPs). 200. A more precise method would tie the deduction to $X times the number of members, so that cooperatives with more members (and therefore more difficulty in organizing) could receive a higher exemption ceiling. 201. This subsidy is currently given without limit to credit unions-cooperative banks-which likely has helped them reach their current level of operations. 26 U.S.C. §501(c)(14) (2012); U.S. Gov'T ACCOUNTABILITY OFFICE, GAO-06-220T, FINANCIAL INSTITUTIONS: ISSUES REGARDING THE TAX-EXEMPT STATUS OF CREDIT UNIONS 8 (2005). 202. Donald A. Frederick, Income Tax Treatment of Cooperatives: Distibutions, Retains, Redemptions, and Patrons' Taxation: Cooperative Information Report 44, Part 3, U.S. DEP'T OF AGRIC., RURAL DIv 14-16 (2005), http://www.rurdev.usda.gov/rbs/pub/cir443. pdf. Although rare in practice, cooperatives can instead choose to pay immediate corporate- level tax on retained earnings and then receive a credit when the retained earnings are later distributed, at which point they are taxable to the distributees, but in this case too, tax is paid immediately. Id.; Donald A. Frederick, Tax Treatment of Cooperatives.: Cooperative Information Report 23, U.S. DEP'T OF AGRIC., RURAL DIV, http://www.rurdev.usda.gov/rbs/ pub/cir23/ClR23.html (last visited Mar. 22, 2014) (stating that most cooperatives elect to have patron-owners pay tax). 2014] THEPUZZLINGLACKOFCOOPERATIVES 949 cooperative activities helps the cooperative accumulate capital during its early years of operation, when capital is often most needed.203 Adjusting X for industry or other factors could ensure the stimulus applies only to those inframarginal situations where individual expected returns from organizing the cooperative are too low, rather than also applying when there are already enough market-based incentives to organize cooperatives.204 A significant virtue of both tax-exempt bonds and deferral of income realization is that distortions are minimized from cooperatives' forming in areas where they are clearly inferior. Both tax-exempt bonds and a tax deferral on retained earnings are tied to the cooperative's market performance. An inefficient cooperative entrant will face not only high borrowing costs as lenders recognize the firm's poor chances for success, but also low earnings as the firm is not competitive. Neither tax-exempt bonds nor a delayed realization of income will be particularly helpful to these cooperatives. Thus, neither of these subsidies will push much development of inefficient cooperatives. One downside, though, is that these subsidies do not directly target the entrepreneur, instead affecting patron-owners generally. This means subsidies may have to be comparatively large to have an effect on entrepreneur behavior, since much of their benefit goes to other owners rather than to the entrepreneur. I next consider more direct alternatives.

2. Alternatives to the Tax Code The tax code need not be the exclusive method of subsidizing cooperatives. In addition to using the tax code, grants, loans, or other direct subsidies could be provided to entrepreneurs starting cooperatives. Such support is regularly given to exempt nonprofits205 and, via a mechanism of the Farm Credit System, to certain rural and agriculture cooperatives." Providing this support to cooperatives

203. See, e.g., BERMAN, supra note 109, at 13, 107 (discussing how undercapi- talization caused failure of some plywood cooperatives); COOPERATIVE CONVERSIONS, FAILURES AND RESTRUCTURINGS: CASE STUDIES AND LESSONS FROM U.S. AND CANADIAN AGRICULTURE, at xiv (Murray Fulton & Brent Hueth eds., 2009), available athttp://www.kis. usask.ca/COOPSBOOK/CoopConversions BookSep09.pdf (discussing the early lack of capital as a frequent cause of potentially viable cooperative failures). 204. Condominiums are an area where market-based incentives already appear sufficient. 205. See supra note 198 and accompanying text (grants). 206. About CoBanl4 COBANK, http://www.cobank.com/About-CoBank.aspx (last visited Mar. 22, 2014). 950 TULANE LAWREVIEW [Vol. 88:899 helps overcome initial funding constraints, which makes forming cooperatives more attractive and reduces required contributions from new patron-owners, in turn broadening the potential owner pool. The advantage of grants or loans is twofold. Unlike tax code subsidies, they provide direct, visible support for starting new cooperatives and should thereby have an immediate impact on cooperative formation. They also can be used to encourage cooperatives in targeted areas where they promise the greatest gains. This flexibility is also a potential drawback. Since grants or loans are untethered to the market's disciplinary force, overly generous usage might induce cooperative formation where cooperatives will likely fail. Restricting grants and loans to cooperatives' formative stages could minimize long-term losses from such exuberance. With both grants and tax subsidies, care must be taken to make sure firms do not organize as cooperatives in name only for these subsidies, while having the attributes of investor-owned firms. Since investor-owned firms lack the organizing difficulties of cooperatives, subsidizing them would be inappropriate. Luckily, addressing this problem could be fairly straightforward.207

3. Encouraging Ongoing Operation? The prior Subparts discussed techniques for financially encouraging cooperative formation. As this Article has shown, a major deterrent to cooperatives is their difficulty in formation, so an effective remedy to this deterrent jump-starts that initial formation. Yet this Part has drawn comparisons between cooperatives and exempt nonprofits, the latter of which receive ongoing subsidies through federal income tax and state property tax exemption in addition to formation stimulus. Should a similar approach be adopted for cooperatives?208

207. Since the key deterrent to new cooperative formation is sharing surplus with fellow owners, a starting point would restrict the subsidies to new cooperatives with (1) a minimum number of members (for example, ten), (2) who share profits based on their patronage with the firm (amount of supplied input, amount of work performed, or amount of product purchased for producer, worker, and consumer cooperatives, respectively), and (3) who allocate voting based on relative patronage or equally across members. The minimum member requirement is already a factor sometimes used by the I.R.S. in determining qualification for tax treatment as a cooperative. IRS Priv. Ltr. Rul. 92-19-030 (May 8, 1992). Combining these requirements ensures that instances where an entrepreneur captures much of the profit produced, and therefore does not face a deterrent to organization, would fall outside these subsidies. 208. Relative to C-corporations, cooperatives already receive preferential treatment because, without undue difficulty, they can structure their income so it is taxed once, generally at the individual-member level. 26 U.S.C. § 1382 (2012). But in many circum- 2014] THEPUZZLING LACK OF COOPERATIVES 951

While both cooperatives and exempt nonprofits have similar difficulties in formation, there is a key difference between the two. Exempt nonprofits generally provide an ongoing service with positive social spillovers that benefit society as a whole, 2" but no such requirement is demanded of cooperatives.210 When activities affect more than just owners, providing the activity is a two-part problem: the provider must be encouraged both to organize andto operate. The ongoing subsidy that exempt nonprofits receive can therefore be seen as subsidizing operations that would otherwise be underprovided.21' When the benefits of an activity are largely captured by owners, no operational subsidy is required to ensure an efficient level of operation by the firm. While an ongoing subsidy to cooperative activities would increase the (discounted) initial profitability of the venture and encourage cooperative formation, much of the subsidy would leak to patron-owners, rather than the entrepreneur whose organizing activity is the one most in need of subsidy, and would therefore be a costly method of subsidy. Even more disturbingly, an ongoing subsidy could induce cooperatives to form and remain in markets where they have no competitive advantage over other ownership forms.212 For these stances, investor-owned firms, including C-corporations, can attain identical treatment. Most investor-owned firms, large and small, achieve this result merely by organizing as an alternative to a C-corporation, such as a limited liability corporation, limited liability partnership, or S-corporation, all of which allow for income to be taxed only once as long as the organization is not deemed publicly traded. Id § 7704; RIBSTEIN, supa note 24, at 193- 246. C-corporations, if under $50 million in gross assets, can also achieve single taxation. 26 U.S.C. § 1202(d). See generallyVictor Fleischer, Taxng Founders' Stock, 59 UCLA L. REv. 60, 63-64 (2011) (discussing how entrepreneurs can obtain preferential tax treatment in investor-owned firms); Victor Fleischer, "Tax Extenders" that Slip Under the Radar, N.Y TIMEs DEALBOOK (Jan. 15, 2013, 2:47 PM), http://dealbook.nytimes.com/2013/01/15/tax- extenders-that-slip-under-the-radar/ (explaining how this tax exemption is applied). 209. This requirement appears in the statutory exemption requirement. 26 U.S.C. § 501(c). 210. Although on occasion cooperatives do as well, many times cooperative activities have only minimal positive externalities beyond those capturable by cooperative members. 211. See generally Molk, suprd note 194, at 480-82 (discussing this justification of nonprofits' exemption). Consistent with this idea, when nonprofits cease activities with positive externalities, their exemptions are subject to revocation. Such was the case with nonprofit health insurers, whose exemptions were revoked as part of a comprehensive tax reform in 1986, when it was determined they no longer provided a public benefit. H.R. REP. No. 99-426, at 664 (1985) ("The committee is concerned that exempt charitable and social welfare organizations that engage in insurance activities are engaged in an activity whose nature and scope is so inherently commercial that tax exempt status is inappropriate."); 26 U.S.C. § 501(c), (in). 212. See Peter Molk & Arden Rowell, Reregulationand the Regulatory Thelhne (draft on file with author) (discussing long-term consequences of regulatory policy). 952 TULANELA WREVIEW [Vol. 88:899

reasons, individual cooperatives should not be subsidized over longer time periods, as are exempt nonprofits.

B. Reducmng Reguladon Independent of financial incentives that help start cooperatives, certain regulations applying to cooperatives could be eased. Effective 23 regulation corrects market failures that would otherwise arise. ' Antitrust regulation prevents harmful restraints of trade. 214 A system of labor laws protects worker interests from employer exploitation."' Various consumer protection laws keep consumers from being ripped off by firms. 216 Many cooperatives also offer these same protections to their owner-members by virtue of their organizational structure. Producer cooperatives, for example, solve problems of producers being exploited by a buyer with market power. A firm owned by its workers lacks incentive to allow unsafe working conditions or to otherwise take advantage of its worker-owners. And a company owned by its customers lacks reason to sell them inferior products. Often, however, regulators do not distinguish among ownership forms. Insurance companies, for example, are generally subjected to the same regulatory scrutiny whether they are investor-owned or owned by their policyholders, despite the latter's structure for consumer protection.217 Cooperatively owned credit unions are largely subject to the same regulation as are traditional banks.218 Nor do courts

213. HANSMANN, supra note 12, at 151. 214. 15 U.S.C. § 1 (2012). 215. 29 U.S.C. § 1(2012). 216. See, eg., 15 U.S.C. § 3601 (condominium and cooperative conversion protection and abuse relief); id. § 6101 (telemarketing fraud and abuse). 217. For example, solvency regulation often does not account for ownership form despite cooperatively owned insurers' theoretical and demonstrated consumer protection behavior. See Martin Eling & Ines Holzmilller, An Overview and ComparisonofRisk-Based CapitalStandards, 26 J. INs. REG. 31, 34 (2008) (discussing the RBC formula, which does not account for ownership structure in the primary form of solvency regulation). But see Capital and Surplus Requirements for Companies, NAT'L ASS'N OF INS. COMM'Rs, http://www.hhs. gov/cciio/initiative/capital-and-surplus-requirements forcompanies-b webb_508.pdf (last visited Mar. 22, 2014) (showing some states have additional capital requirements that vary by ownership form). 218. For example, both credit unions and banks are subject to the same general regulations. Are Credit Unions Regulated or Supervised by the FederalReserve System., FED. RESERVE BANK OF S.F (Mar. 2005), http://www.frbsf.org/education/publications/doctor- econ/2005/march/credit-unions-regulation-supervision; Reserve Requirements, BD. OF GOVERNORS OF THE FED. RESERVE Sys., http://www.federalreserve.gov/monetarypolicy/ reservereq.htm (last updated Nov. 5, 2013) (reserve requirements); Comparihg Credit Unions Kith Other Depository Institudons, U.S. DEP'T OF TREASURY 5 (Jan. 2001), http://www. 2014] THEPUZZLINGLACK OF COOPERATIVES 953 or juries appear to account for ownership structure in products liability or consumer fraud cases, again despite cooperatives' lacking motive for this activity.219 And although worker-owned firms are few, regulators have shown no tendency to give them any lower oversight. Recognizing that there is less need to regulate cooperatives that, by virtue of their structure, protect their patron-owners would save cooperatives compliance costs and regulators the expense of regulating cooperatives. Cutting back on these regulations can stimulate cooperative formation both by reducing regulatory hurdles to formation and by increasing profitability by saving on regulatory compliance. Of course, just because a cooperative lacks the incentive to exploit individuals does not guarantee that exploitation will not occur.220 For this reason, regulation of cooperatives should not be entirely eliminated. But understanding that the protection offered by regulation can be duplicated by the protection inherent in the cooperative ownership form offers opportunities to reduce unnecessary oversight.

C Other Tools There are a myriad of other ways that cooperative formation could be stimulated beyond the financial and regulatory methods outlined here. For example, a policy could be adopted requiring all firms in a particular industry to be organized as cooperatives. The danger of such a policy is that it might be applied to industries where cooperatives fail to offer efficiencies, so that social welfare is reduced as an inefficient ownership form is adopted. The benefit, of course, is that it would be very effective at jump-starting formation of cooperatives. Intrusive though such a policy might be, it is commonly applied to the legal and medical professions, where regulations require that only lawyers and doctors be allowed to own legal and medical treasury.gov/press-center/press-releases/Documents/report3O7O2.doc ("[Mjost of the remaining major regulatory differences between credit unions and other depository institutions [have been] removed."). 219. For example, policyholders regularly bring suit against policyholder-owned insurance companies for this behavior, yet no references to the ownership structure's protective mechanism is made. See, e.g., State Farm Fire & Cas. Co. v. Bongen, 925 P.2d 1042 (Alaska 1996). 220. For a particularly prominent example, see State Farm Mutual Automobile Insurance Co. v Campbell,538 U.S. 408, 429 (2003) (upholding a $145 million punitive damage award against cooperative insurer). 954 TULANE LAWREVIEW [Vol. 88:899 practices respectively-meaning that law firms and medical practices must be organized as worker cooperatives.22' Academics have had difficulty rationalizing these anticompetitive rules.222 However, if the ongoing benefits from worker ownership exceed those of investor ownership in these industries, such regulatory intervention could be welfare-enhancing. Because investor-owned firms start more readily than cooperatives, if law firms and medical practices were opened up to investor ownership, there is a risk that investor ownership would come to dominate, even though it produces lower social benefit than does cooperative ownership. There are alternatives to regulatory mandates requiring the cooperative form. Policies could address the coordination costs that keep existing firms from converting to cooperatives by, for example, requiring firms reorganizing in bankruptcy to make a good faith offer to sell to a group of the firm's patrons. Or, policies could enhance other preferences to promote development of social entrepreneurs, who might then be willing to start cooperatives223 or conduct publicity campaigns extolling the virtues of cooperatives to reduce the costs of assembling co-owners and make both start-ups and conversions more likely. Strong objections have been raised against intentional shaping of individual values,224 but in many circumstances, some shaping is unavoidable.225 For example, a federal program issuing grants to cooperatives may act as an implicit endorsement that increases cooperatives' legitimacy in the public's mind, possibly both enhancing cooperative creation and spurring other related behavior.226 I take no position on the propriety of

221. MODEL RULES OF PROF'L CONDucT R. 5.4 (1983); Renee Newman Knake, Democratizingthe Delivery ofLegal Services, 73 OHO ST. L.J. 1, 14-15 (2012); William M. Sage & David A. Hyman, Combatng AntinicrobialResistance: Regulatory Strategiesand InstitutionalCapacity, 84 TuL.L. REv. 781, 804 (2010). 222. See, eg., Thomas R. Andrews, Nonlawyers i the Business ofLaw: Does the One Who Has the Gold Really Make the Rules? 40 HASTINGS L.J. 577, 655-66 (1989) (discussing the idea ofnonlawyer owned law firms); Roberta S. Karmel, WillLawFhms Go Public?(Brooklyn Law Sch. Legal Studies Research Papers, Working Paper Series, Research Paper No. 321 at 1, 2013), http://ssm.com/abstract-2205709. 223. See Lynn A. Stout, Social Norms and Other-RegardingPreferences, in NORMS AND THE LAw 13, 32-33 (John N. Drobak ed., 2006) (exploring how to shape preferences). 224. See, e.g., Edward L. Glaeser, Paternalismand Psychology,73 U. CI. L. REv 133, 133-34 (2006); Gregory Mitchell, Review Essay, LibetarianPaternalism Isan Oxymoron, 99 Nw.U. L. REv 1245, 1246 (2005). 225. RICHARD H. THALER & CASS R. SUNSTEIN, NuDGE 9-11 (2009); Cass R. Sunstein & Richard H. Thaler, LibertanianPaternalism Is Not an Oxymoron, 70 U. C. L. REv. 1159, 1164 (2003). 226. See generally Lynch v. Donnelly, 465 U.S. 668, 688 (1984) (O'Connor, J., concurring) (noting the legitimizing message sent by government's endorsement or 2014] THE PUZZLING LACK OF COOPERATIVES 955 using these methods to initialize cooperative formation, but only identify them as potential techniques.

D. How Much To Incentivize? I now come to the tricky issue of calibrating how much cooperative subsidy is appropriate. For subsidy through decreased regulation, regulation should be cut back only in those markets where cooperatives offer the protection that regulation otherwise affords, and then only by how much protection the form offers instead of by how high formation hurdles are. Final calibration can happen through tax- code subsidy, grants, or other means. Ideally, cooperatives would be subsidized to the point where firms choose their organizational structure based only on which is most efficient, rather than which has the lowest barriers to organization as often occurs today. This subsidy amount cannot be known ahead of time, so subsidy rates must be adjusted based on observation over time. Some guidelines follow. As cooperatives succeed in a particular industry, the difficulty in starting one, while still present, diminishes. Demonstrated success not only makes cooperatives more familiar and legitimate to potential patrons and entrepreneurs, but also should reduce their perceived start- up risk and provide models on which future cooperatives could be patterned. This makes it easier to assemble co-owners and increases the likelihood that future entrepreneurs and brokers might consider cooperatives as a viable option. Thus, while support might be relatively heavy as cooperatives gain critical footing in new industries, the level of support can be decreased over time as cooperatives succeed. For example, any support for cooperatives in property insurance, where cooperatives are already familiar,227 should be less than the support for cooperatives in health insurance, where cooperatives currently have no significant presence. In addition, if more industries develop viable institutions for brokering cooperative ownership, as has arisen for condominiums, support could be further reduced. A robust brokering process effectively solves cooperative formation difficulties. 228 If these institutions form as cooperatives penetrate new markets, external support could be withdrawn. disapproval of a religion); Benartzi, supm note 88, at 1748 (noting that employer allocation of retirement contributions acts as an endorsement to employees). 227. See sources cited suprd note 99. 228. SeesupmPartIV 956 TULANE LAW REVIEW [Vol. 88:899

Combining these points gives a general structure for cooperative support. First, reduce regulation as appropriate. Then, identify areas where cooperatives can fix market failures, but which currently have no developed brokering institution. Next, subsidize cooperative formation in those areas through tax policy, grants, or other means until a critical mass of cooperatives forms. As cooperatives flourish, subsidy rates can be reduced, and in those areas where brokering institutions develop, subsidies can be withdrawn completely. When structuring this support, it may become apparent that the costs of subsidizing cooperative formation in certain industries outweigh the incremental social benefits that cooperatives might offer.' In those circumstances, the proper approach is to refrain from subsidizing cooperatives, even if they would be more beneficial once up and running, because the ongoing benefits do not exceed the cost of subsidy. Without conducting such a deliberative analysis, however, a policy like the current approach that generally refuses to subsidize cooperative formation cannot be supported, given the difficulty cooperatives have in starting and the lack of viable brokering institutions.

E An Application: Health InsuranceCooperatives As part of the Affordable Care Act, Congress made available $2 billion in funding to subsidize the formation of health insurance cooperatives, as an alternative to a public option.230 While it is too early to know if these pilot insurers will succeed, it is not too early to compare briefly the subsidization of these companies with the strategies outlined earlier in this Part. I develop a fuller analysis elsewhere."' Health insurance has several of the characteristics indicative of cooperative success. Buyers are comparatively small and face a restricted set of large sellers, giving sellers market power over these transactions.23 Both buyers and sellers have private information they

229. Some of these benefits will be difficult to quantify precisely. Welfare gains from nonfinancial ownership motivation or the incremental development of positive externality goods are two examples. Note in addition that subsidizing cooperatives today may reduce the costs of doing so in the future, so sizable immediate subsidies may be worthwhile if future subsidies could be lower such that long-term payoffs are sufficiently large. 230. See supm note 4 and accompanying text. 231. Peter Molk, The Owneahip ofHealth Insers(draft on file with author). 232. Id. 2014]) THE PUZZLING LACK OF COOPERATIVES 957 can use to exploit the other.' Insurers have opportunities to provide positive externality goods." Capital requirements also are not unduly high.2 35 Consumer familiarity with cooperative health insurers is likely low, however, since existing cooperative presence in this field is negligible. "' Further, no brokering institution has developed. Consequently, Congress gave these cooperatives generous initial subsidies by exempting cooperative earnings from income tax and by lending money to them at below-market rates. 2' Given the unfamiliarity with cooperatives in this market, significant initial subsidies are not unwarranted to help overcome start-up barriers. Congress, however, did not exempt the health insurers from consumer protection regulations or indeed any insurance regulations.238 Exemption from regulations could be desirable if they duplicate the cooperatives' protective function.' Congress's income tax exemption for insurers' earnings also appears to be perpetual, rather than temporary, despite the fact that most services provided by these insurers will accrue directly to policyholder-owners, rather than society at large, and so need not be subsidized on an ongoing basis like exempt nonprofits' ongoing activity.240 This perpetual subsidy raises the possibility that these cooperatives may persist over the long term even if they are inefficient. While the idea of subsidizing these insurers may have been appropriate, the ways Congress chose to do so were not.

VI. CONCLUSION Given their demonstrated potential for maximizing benefits of ownership, the lack of cooperatives in the modern economy is puzzling. Existing theories about the costs and benefits of cooperative ownership explain when a cooperative will succeed once up and

233. For instance, buyers have private information about their susceptibility to certain medical conditions, while sellers know which and how much of a particular treatment they will approve, the particulars of which are not disclosed in the insuring agreement. 234. For example, an insurer cannot exclude a policyholder's future insurers (or society at large) from enjoying lower future health expenses that vaccinating a policyholder today might bring. 235. The health insurer generally acts as an intermediary between the customer and the medical provider and need not provide any capital-intensive activities of its own. 236. See supm note 170 and accompanying text. 237. Patient Protection and Affordable Care Act, Pub. L. No. 111-148, § 1322, 124 Stat. 119, 187 (2010); 26 U.S.C. § 501(c)(27) (2012). 238. Patient Protection and Affordable Care Act § 1322. 239. Id. §§ 1322(c)(5), 1324. 240. See sources cited supm note 194. 958 TULANE LA WREVIEW [Vol. 88:899 running, but they do not account for the barriers that inhibit initial cooperative formation. This Article identifies this problem while offering suggestions for fixing it. Because ownership of enterprise is disproportionately held by less-efficient investor-owned firms, policies that promote cooperative ownership stand to improve welfare by solving market imperfections, supplying more positive externality goods, decreasing prices, increasing product and service quality, and reducing the need for costly regulations and oversight. These benefits spill over into broader society, making cooperatives worthy of support.